How much shall I save? You need to save at least slice of your income, preferably a chunk. A sliver isn't enough. [ A chunk is 2 slices, a slice is two slivers]. A slice is 8.33%.
Its a piece of cake. A twelfth. A month's salary. Two months is good, three months great. Perhaps not coincidentally the new style UK personal pension schemes will kick in at 8%. And the old style pensions rules used to limit tax relief to 15% of your income. Again that's saving around 1-2 months salary every year.
Where shall I stash my savings? This isn't a what to buy? question. That comes next. This is about which tax regime? should my savings grow in. The three most popular are ISAs, pensions, and your home. Each has special tax concessions.
ISAs have no further tax to pay, and a very flexible. Buying your own home isn't flexible, but there is no income tax [on the rent you save] and no capital gains tax. The pensions tax regime offers a tax free lump sum [25% of pension value] and tax deferment. On the downside it is the least flexibile. You can't access any cash until you are at least 55 [or 65 for men's state pension], and even then you can't get your hands on all of it.
So you could stash all your savings in an ISA, or use it to pay off your mortgage early, and have very little to do with the pensions tax regime even though you think of yourself a saving for your 'pension' [as in 'my house is my pension']. Governments like the pensions (tax) route because it limits you to when you can spend it [see the last question, below]. And the finance industry like it 'cos they can charge you fees. Of course home owning isn't a fee-free zone - as anyone switching mortgages can testify.
What to buy? Is the traditional big question. The industry is ready with the answer: 'Buy our unit trusts, endowments , emerging markets funds....' by which they really mean 'pay our fees'. For vanilla investors this question is about your asset allocation. How much in boring assets [gilts and cash] and how much in bouncy [shares and commercial property].
When to cash in? Even within the state scheme you can opt to delay your pension. Those with money-purchase pension schemes also have an additional question. Do I take an income (also known as drawdown) from my personal pension fund, while leaving it invested - or do I buy an annuity with it. Or can I do both?
Thats the questions - what are the answers?
It depends.
How much?
Lets look at what Robert on £36 000 a year does..
Robert decides he can save £4500 a year [an eighth - a month and a half's worth, not bad]. Over 35 years thats £250000 - [if the real interest rate after inflation is 2.5%, ie he ends up with £250 000 in todays money].
Where?
Robert decides to pile it all into paying off his mortgage early. He manages this by his mid40s, and switches his savings into an ISA. There was a five year period when he did both - because he was worried his ISA allowance might not be big enough to cover all the savings he wanted to make in his fifties. He was hoping he would hit the 40% tax band, when he would have started saving into a pensions wrapper because of the tax relief. But he never quite earned enough. And the standard tax relief wasn't enough to tempt him.
What to buy?
Robert just splits his fund equally between index linked gilts and shares [the FTSE 100] . He finds an etf [like a tracker] for each area. He only has two holdings. Its not ideal. He has no overseas holding. And gilt funds are not the same as gilts [the latter are redeemed - gilt funds aren't]; but compared to many of his friends he has done ok. Most of his money went to pay off the mortgage. His friends still have a mortgage - and a big hole in the value of their shares holding
When to take your pension?
Because Robert's money is in his ISA he can take the money out any time.... He doesn't have to wait until he is 55 - or be pushed into buying an annuity before he is 75. We'll come back to this later when we look at someone who has saved/trapped all his money in a pension scheme.
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