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Why its never too late to start investing for your retirement
Thursday 13 Aug 2020 Author: Tom Selby

When it comes to saving for retirement many of us bury our heads in the sand and it is easy to leave it so long that you fall into the trap of feeling it is too late to start.

However, this is not the case and in the second part of this series, we looks at some of the key things savers in their 40s should be thinking about as they build their retirement pot.

IT’S NEVER TOO LATE TO START

Although ideally you would have already started saving in a pension by your 40s, this won’t be the case for everyone.

In fact, in many ways people in their 40s are most at risk of falling short of their retirement aspirations, having by-and-large missed out on the glory years of generous guaranteed defined benefit pensions (unless you work in the public sector of course) and with less time to benefit from ‘automatic enrolment’ reforms which now require employers to offer workplace pensions to staff.

Nonetheless, if you are employed your workplace pension is still the first place to start when saving for retirement. At a minimum your personal auto-enrolment contribution will be 4% of ‘relevant earnings’, with your employer matching up to 3% and a further 1% coming via pension tax relief. For 2020/21 ‘relevant earnings’ include all salary between £6,240 and £50,000.

Bear in mind that if you opt-out of your auto-enrolment scheme you’ll effectively be refusing free money, so make sure you stay in if you can afford to.

One very rough retirement rule of thumb is to aim to set aside half the age at which you started saving as a percentage of your salary each year. For example, if you’re 40 this would mean you need to save 20% of your salary.

Such a level might be beyond your means, but the principle should be to put as much as you can into your retirement savings.

DON’T PANIC

If you are in your 40s and haven’t started saving for retirement yet, don’t panic – you are not alone. Lots of people at this stage of life will have spent most of their 20s and 30s saving for a house or raising young children.

Furthermore, millions of people – including low earning employees and the self-employed – are not included in the auto-enrolment. If you consider the self-employed – representing around 5 million workers at the last count – roughly one-in-seven are saving in a pension at the moment.

Remember that even if you don’t qualify for a matched employer contribution through auto-enrolment, pension tax relief still provides a strong incentive to save for retirement.

This will automatically convert an £80 contribution into a £100 in a pension, while higher and additional-rate taxpayers can claim back extra tax relief from HMRC. Some workplace schemes – such as salary sacrifice pension arrangements and ‘net-pay’ schemes – will pay this tax relief automatically provided your contribution comes from salary taxed at 20% or higher.

Because of this generous tax treatment, annual pension contributions are capped at £40,000 for most people (or 100% of your UK relevant earnings if this is less than £40,000).

Furthermore, 25% of your fund will be available tax-free from age 55 (this is due to rise to 57 by 2028) and you’ll also have total flexibility over how you take an income from this point onwards.

A NEST EGG FOR YOUR KIDS

For lots of savers in their 40s the focus isn’t just on their own savings but building a pot of money tax efficiently for their children as well.

Your kids may be moving through the school system with the task of providing for higher education getting closer. There are two ‘junior’ versions of traditional savings wrappers you can consider.

You can save up to £2,880 on your child’s behalf in a Junior SIPP and it will be topped up automatically via pension tax relief to £3,600. The mechanics of tax relief are exactly the same as for an adult saver, just with a lower annual contribution limit.

In all other ways a Junior SIPP works in exactly the same way as a regular SIPP, with 25% of the pot available tax-free from age 55 (due to rise to age 57 in 2028) and the rest taxed in the same way as income.

The other main option is a Junior ISA. Junior ISAs received a significant boost at the latest Budget, with the annual allowance more than doubling from £4,368 to £9,000. Once your child reaches age 18 their Junior ISA will convert into an adult ISA and they will be able to access the money-tax-free.

MAKE A PLAN (IF YOU HAVEN’T ALREADY)

For most people in their 40s there will be a number of competing financial priorities. For example, many will have their sights set on paying off debts, saving for a first home or building a pot of money for their children’s further education.

Try and block out a wet Sunday afternoon when you can write down your outgoings and incomings. This is a good start in terms of understanding what you truly can afford to set aside for later life. Even if you’re concerned you’ve already left it a little late, don’t let that be an obstacle to starting now, the earlier the better.

If you haven’t already, it also makes sense to build up a decent-sized ‘rainy day’ fund in an easy access cash account you can access quickly in case of emergency. Aiming to have around three months’ fixed expenses in this emergency account is a good place to start, and make sure you shop around for the best interest rate you can find.

THE RIGHT INVESTMENT STRATEGY

Getting the right investment strategy in place is a crucial part of retirement planning. This will be determined by a number of things, including your attitude to risk and investment time horizon.

If you’re in your 40s, in most cases you won’t be planning to access your retirement pot for 20 or even 30 years. This is a lengthy time horizon in anybody’s book, and should provide scope to take some investment risk.

Your employer picks your auto-enrolment pension for you. The ‘default’ investment fund, assuming you do nothing, benefits from a cap on charges currently set at 0.75%. This fund will not aimed at the broad scheme membership rather than being tailored to your risk appetite and needs.

If you’re choosing your own investments in a product like a SIPP, once you’ve established the level of risk you’re happy with it is crucial to keep your costs as low as possible.

Over times costs can really eat into the value of your pension, particularly when you are dealing with a time frame which runs into decades.

In terms of cost, active funds tend to have higher charges than passive (although active managers say this charge is justified because they have the skill to deliver higher returns).

It’s also important to ensure your investments are spread or ‘diversified’ around different sectors and countries so you don’t have all your eggs in one basket. If you aren’t confident in doing this yourself, you can pay a fund manager to do it for you.

Having reached the point where you are comfortable and satisfied with the risk profile and individual components of your investment portfolio then you should be able to more or less sit tight until you are somewhere around five or 10 years from retirement. Most of the time the last thing you want to do is trade too often as this will layer on extra costs with no guaranteed benefit.

WHEN THE MORE COMPLEX PARTS OF THE RETIREMENT SYSTEM COULD BECOME A FACTOR

For a relatively small section of the population, the more complicated parts of the pension system – namely the lifetime allowance and tapered annual allowance – could creep into play as they reach their late 40s.

The lifetime allowance is a cap on the amount you can save in a pension over the course of your life and is set at £1,073,100 for the 2020/21 tax year. If you go over the lifetime allowance when accessing your pension you will pay a tax charge designed to return the tax relief you have received.

The annual allowance taper is one of the most complicated parts of the pension system.

While most people enjoy a £40,000 pensions annual allowance, those with ‘threshold’ income above £200,000 and ‘adjusted’ income above £240,000 have their annual allowance reduced by £1 for every £2 of adjusted income earned above £240,000, to a minimum of £4,000 for those with adjusted income of £312,000 or more.

Note that both income measures include not just salary but other taxable income too. Threshold income also deducts any personal pension contributions, while adjusted income adds employer contributions.

Those with generous defined benefit entitlements, such as senior doctors, have been among those caught by the complexity of the taper. Again, if you breach your allowance the taxman will come for any tax relief you have received over and above your annual allowance.


COMING SOON

Don’t miss next week’s pensions article, looking at what people in their 50s should do with saving for retirement.

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