The financial diary of a twentysomething's quest to invest her way on to the property ladder
Is 24 too young to start thinking about retirement? A few months ago I’d have said: “Absolutely”. But I’m no longer so sure.
A 25-year-old on an average salary of £28,700 (not unlike me) working until the age of 68 could expect an income in retirement of just £5,600 a year, wealth manager Quilter has calculated. Today's retirees enjoy more than double that.
If I want to be booking round-the-world cruises, just one of which could blow that £5,600 annual budget, I’d better start saving – and fast.
Pensions are often seen as the dowdy older sister of investments: less sexy, more bingo and bowls clubs. In fact, I've realised that most of my friends don’t even know their pension is invested.
The great thing about your pension being put into stocks and shares is that the money going in has the potential to grow over time – so the more time you have the better.
In this column I’m trying to turn a £10,000 inheritance into the £40,000 I’d need to put down a deposit on the average London home in 10 years' time. If you can grow £10,000 into four times that amount in a decade, just think what you could do with your money in 30 or 40 years.
Based on current forecasts, I'll reach state pension age when I turn 68 in 2063. That means I have a little over 43 years to save. So how much do I need to be putting away to fund my later years?
The generally accepted wisdom is that you’ll need around two-thirds of your salary to maintain your current lifestyle after you stop working. For me, that would be an income of £20,000, which means I would need to have saved up a retirement pot of around £366,000.
The majority of millennials are now auto-enrolled into a pension by their employer. They have to put in at least 5pc of their annual salary and their employer must add a minimum of 3pc on top of that.
Pensions firm Aegon worked out that, even with these contributions, a 25-year-old earning £30,000 would still be almost £200,000 short of this "two-thirds of salary" sweet spot when they turn 68. It assumed salary increases of 3pc a year and annual inflation of 2pc.
To make up that gap I’d need to top up my 5pc pension contribution by a further 9pc, bringing my total amount to 14pc. That's an extra £225 per month, which because of the tax relief on pensions would only cost me £180.
If I complacently waited till I turned 35 to think about my pension I’d need to start putting away £350 a month, equal to £280 of my post-tax pay – a pretty hefty chunk. That’s because I’d already have missed out on 10 years of possible growth on my pension investments.
So, time for some action. I contacted The Telegraph’s pensions department to ask how I could increase my pension contributions so I was saving 14pc of my salary.
Luckily I have a generous workplace scheme, so I only needed to put in an additional 4pc (on top of the 5pc) to reach this point, with the rest paid in by my employer.
Putting more of my income into my pension pot also means the taxman will take home a smaller slice of my earnings – a win-win for me.
Where does that leave my finances today? On a salary of £30,000, I pay just over £3,000 in tax and around £2,500 in National Insurance Contributions, and I'm putting £2,148 into my pension.
After my student loan repayments, this gives me a take-home pay of around £1,800 a month.
Of this, around £750 goes on rent and bills, and I squirrel £200 into my stocks and shares Isa, where I'm investing in the hope of putting down a deposit on a home within 10 years.
All this saving and investing means I still have £850 to live off for the month.
This pension plan would cover my “basic” retirement needs of £20,000 a year (plus a few luxuries); but what about my dream retirement – one that would fund me beyond the essentials? Could I be ambitious enough to hope for a pension pot worth £1m by the time I finish working?
It turns out retiring a millionaire is not actually as hard as it seems – if you start early enough.
Assuming my pension investments achieved returns of 4.25pc (a reasonable estimate after fees), I’d have to save just £500 a month for the next 43 years, according to Aegon.
If I took a bit more risk with my investment choices, I could potentially do even better. With returns of 8pc (7.25pc after fees), I’d need to be squirrelling away just £235 a month.
A £1m pension pot would give me an income of around £30,000 a year in today’s money and given current life expectancy. But who knows, maybe by the time I hit 68 we’ll be living forever. Suddenly £1m doesn’t sound all that much to live off.
I’ll be answering questions on pensions in my next Q&A which will be on the Telegraph’s website next week. If you have any queries or comments about today’s column let me know on [email protected].