Aged 20 and saving for the 100 year life

You’re in your 20s. Your career is at an early stage and the demands on your income are many. You’re acutely conscious of the tens of thousands of pounds of debt you racked up as a student.

At some future point you hope to buy a property, but that is, at best, a distant goal.

Surely saving toward your retirement should be at the very bottom of your financial priorities?

Not quite. Your youth gives you a once-in-a-lifetime advantage. Your income may be tightly constrained at the moment, but there is one commodity in which you are richer than most: time. It means that by starting to make long-term savings now, the total proportion of income that you’ll have to sacrifice over the course of your future career should – all else being equal – be less than when someone starts saving for the same goal at a later age. It’s an advantage that fades with age.

Calculations undertaken by Cazenove Capital and Schroders, based on a range of assumptions, have sought to pinpoint exactly how much of their income a 20 year-old would need to put by now if they wanted to fund a retirement that would take them from the day they start collecting their state pension (at age 68, according to current rules) to the age of 100.

Our calculations – spelled out in forensic detail below – highlight the great advantage of relying on time to boost your returns. Technically referred to as compounding, what you are benefiting from is investment returns that are re-invested to attract further returns – and so on. Where savers start young, that compounding process does much of the heavy-lifting.

It is unrealistic for someone in their 20s to commit all their savings into a pension, where strict rules apply as to how and when the money can be spent.

So in order to make our calculations more realistic – and helpful – we’ve assumed the savings will go into a mix of both pensions and Isas. The latter are more flexible and would allow for earlier withdrawals if, for example, you needed to access cash to meet an earlier objective – such as helping with a property purchase.

Any sums you’re given or inherit at any stage could, of course, be added to your overall savings, where they would contribute to total growth. We haven’t counted on any such top-ups here.

For the purposes of the calculations we’ve assumed you’re aged 20 and earning £20,000. Your wages rise with promotions at age 25, 30, 40 and 50 to £25,000, £30,000, £35,000 and £40,000, respectively (see below). Your wage also rises in line with inflation (2.5%) throughout your career. Exactly how much you are required to save – and how rapidly your investments are expected to grow – is laid out below.

Why save for the 100-year life?

Being able to fund a retirement to the age of 100 is becoming increasingly important.

Healthcare improvements and lifestyle changes mean there is a 20% chance of a man and 27% chance of a woman aged 20 in 2018 living to 100, according to data published by the Office for National Statistics (ONS).

Even if you don’t make it quite to a century, the chances of getting near are high. The average life expectancy for men and women born in the late 90s and alive today is 88 and 91 years of age, respectively.

What do I need to do to get saving?

Let’s start with the target objective. Let’s say you want to retire at 68 on about £27,000 per year in today’s money. That should be enough to pay your household bills and extras such as leisure activities and holidays until your 100^th birthday.

To achieve that aim you’d need to be saving an average of around 11% of your earnings per year from now.  Our calculation takes into account investment returns, inflation, tax and a range of other factors, and assumes you’ll be receiving the full state pension.

This is how your earnings are spent on average per year over your working life in today’s money:

The assumptions

Due to the complexities and uncertainties of saving for retirement we have based our calculations on current UK legislation. Each person will have different needs and requirements, so we have also made the following assumptions to keep the calculations simple:

• Your salary starts at £20,000 and rises with promotions at age 25, 30, 40 and 50 to £25,000, £30,000, £35,000 and £40,000, respectively
• Your wage also rises in line with inflation (2.5% per year)
• There are no bonuses
• You have no dependants
• 3% of your salary is paid into a company pension, and your company puts in 4%
• 8% of your gross salary is paid into a tax-efficient investment Isa
• The Isa annual allowance, currently £20,000, increases by the rate of inflation
• Pensions and Isa investments return 5% a year after fees (remember that past performance offers no guide to future returns and your capital is at risk when investing)
• The state pension is still available and rises based on current legislation of a minimum of 2.5% a year
• You will retire at 68 and live until 100.

Please remember these calculations are for illustrative purposes only. There might be more tax efficient ways to save and spend your money. You should consult an independent financial adviser. Investments can go down as well as up and future returns are not guaranteed. Your capital is always at risk.

James Gladstone, Head of Wealth Planning at Cazenove Capital, said: “The example we’ve given here is only theoretical – it’s just one way of doing it and nothing is guaranteed given that reaching the targets depends on future investment returns which are unknown.

But what it does show is the amazing potential power of compounding. Most people in their 20s have little cash to spare – but thanks to the length of time involved, even modest initial contributions can mount up exponentially.

How your retirement savings add up: Age 20-68

Now you know the assumptions, here is how it works.

Example: Isa savings

In the first five years of your working life very little of your £20,000 income will be paid into your Isa. Due to the costs of living it is unlikely you will have much disposable income after covering your basics such as rent, socialising, phone costs etc.

Once you hit 25 and your salary increases to £25,000 then you will start saving roughly the equivalent of 8% of your gross income per year into an Isa, the value of which is assumed to grow thereafter at 5%, compounded year-on-year after fees.

Why 8%? It is what is left over after tax, day-to-day living costs and pension contributions.

Isa savings jump again when you hit the ripe old age of 30 and your salary increases to £30,000 (or £38,403 which is the inflated equivalent in 10 years time). Isa savings rise to £2,697 per year, still 8% of your salary, or the equivalent of £225 per month.

Significant jumps occur in Isa contributions again at the ages of 40 and 50 when your salary rises to the inflated equivalent of £35,000 and £40,000, respectively.

Initially, your savings growth will seem slow. However, the compounding effect sees your investments accelerating over time - providing all goes to plan.

By the end of your final working year - at the age of 67 – if all goes to plan, you might have amassed Isa savings worth £620,632 (adjusted for inflation), as illustrated by clicking on the + sign in the pension section below.

Example: Pension savings

Unlike Isa savings your pension savings will begin at the age of 20. This takes full advantages of the tax benefits and company top-ups available to you when you pay into a workplace pension.

You will pay the equivalent of 3% of your gross annual income into your pension and your company adds a further 4%, the value of which is assumed to grow at 5% per year after fees.

We have used the 3%/4% split because this is the standard contributions to pensions for an employer/employee. More could be contributed to the pension rather than the Isa, but having the Isa allows the person the flexibility to be able to withdraw money from the Isa before the age 55.

At age 25, when your salary jumps to the inflated equivalent of £25,000, you should be putting £849 of your salary, annually, into your company pension, £170 of which is an upfront tax break given to you by the government. Again, it is worth knowing that there are additional tax benefits for paying into a pension.

Your company contributes an additional £1,131. By the end of that year your pension pot could have grown to £10,499, based on the assumptions we described previously. Already your savings are starting to build.

At age 30, when your salary jumps to the inflated equivalent of £30,000, your personal pension contribution should rise to £1,152, £230 of which is an upfront tax break given to you by the government.

The company’s contribution will be £1,536. By the end of that year your pension pot could have grown to £25,608, based on the assumptions we described previously.

Significant jumps occur in pension contributions again at the ages of 40 and 50 when your salary rises to the inflated equivalent of £35,000 and £40,000, respectively.

To see the full calculations click on the + sign below:

Again, you can really see the benefit of saving over a long period as the value of your investment starts to accelerate in the later years of your working life. The value of your pension could more than double in the last 11 years of your working life. By the age of 67 the value of your pension could have grown to £620,191 (adjusted for inflation).

The chart below illustrates how your pension and Isa savings grow over your working life. At age 68 when you retire the value of your pension falls sharply while your Isa continues to rise until age 76.

The fall in the pension is due to a large (25%) lump-sum withdrawal, which takes advantage of tax-free withdrawal rules. A proportion of that lump-sum is then invested into the Isa, which helps keep the Isa growing, more of which below.

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How your Isa and pension savings grow

End of year balance (£)

Source: Cazenove Capital. For information purposes only. The material is not intended to provide advice of any kind. Information herein is believed to be reliable but Schroders does not warrant its completeness or accuracy. Please remember that past performance is not a guide to future performance and may not be repeated.

Don't forget tax

Tax has certainly not been forgotten in our scenarios. For example, in your first year, you could pay tax of £3,120.

At age 20, after tax and all your savings you should have £16,400 left to spend on essentials, which includes rent or mortgage, and leisure. A full year-on-year breakdown can be found by clicking on the + sign below:

What saving for retirement means for your monthly budget

The table below illustrates how an income might be divided between savings, spending and taxes on a monthly basis at ages 20, 25, 30, 40 and 50. The contribution from the company into your pension isn’t included as it doesn’t affect your monthly outgoings after tax. Please remember that the figures shown are at their inflated values for the appropriate age.

 

Please remember that past performance is not a guide to future performance and may not be repeated.

Source: Cazenove Capital. For information purposes only. The material is not intended to provide advice of any kind. Information herein is believed to be reliable but Schroders does not warrant its completeness or accuracy.

How can I withdraw the money in retirement: Age 68-100?

After nearly five decades of saving you should have accrued a healthy retirement pot – made up of both your Isa and pension - providing everything has gone to plan.

It is now time to retire, start withdrawing your money and hopefully make sure your savings last until you are 100. Accessing your Isa is straightforward. However, there are various ways of accessing your pension fund in order to meet your retirement expenditure.

Before we start, it is worth noting that there will be alternative routes to drawing down an income from your savings. For simplicity we have suggested only one route. For example, you might take money from your Isas exclusively and then, when these are exhausted, draw on your pension. The advantage is inheritance tax protection: the pension remains outside of your estate.

Another route could be to use “phased drawdown” where you take series of tax-free lump sums from your pension (i.e. not using your 25% lump sum in one go) and drawing on the Isas and then drawing on the pension.

A third way could be using Uncrystallised Funds Pension Lump Sums (UFPLS) each year which is where you take a lump sum from your pension of, say, £10,000 which is comprised of £2,500 tax free cash and £7,500 of income, any shortfall is then topped up by drawing on the Isas.

We have tried to keep things as basic as possible and used a relatively simple retirement approach for the first four years as an example of what to expect. There is a full breakdown further down the page.

Retirement: Age 68

You should receive a state pension of £34,281, providing it has risen by 2.5% per year.

You could withdraw the full tax free cash allowance from your company pension of £155,048. This would allow you to begin drawing an income from the residual pension fund and also fund expenditure and Isa contributions in the early years of retirement.

The tax free lump-sum could be split three-ways: £29,741 is used to help fund expenditure in your first year of retirement; £63,830 is saved into your Isa (the estimated inflated growth of the Isa allowance). The remaining £61,476 is saved in a bank account.

Total expenditure in your first year of retirement could be £93,522 including taxes of £5,192. Remember that is the inflated equivalent of £27,000 in 48 years’ time. It might sound a lot in today’s money, but prices will have risen in tandem.

To fund that expenditure you could withdraw £29,500 from your company pension as ‘drawdown’ income. Along with your state pension and the £29,741 taken from lump-sum tax-free withdrawal it should cover your basic needs and taxes.

After taxes you should have £88,330 to spend on essentials and leisure. Again, remember £88,330 is the inflated equivalent of £27,000 after taxes in 48 years’ time.

Age 69

The state should pay you a pension of £35,310.

You could withdraw £29,500 from your company pension.

Remember the £61,476 – the remainder of the tax-free lump-sum you took from your company pension in the first year that’s been in your bank account? It is now worth £62,091 because of 1% growth in interest. You could take £30,938 of that to fund your retirement expenditure in year two. There is still money left over, so £31,153 could be saved into your Isa.

Tax is £5,209, leaving you £90,538 to spend on essentials and leisure.

Age 70

Things get much simpler from here on in as your retirement income will now come from three main sources: the state pension, your company pension and your Isa.

• The state should pay you £36,369.
• You could withdraw £29,500 from your pension.
• You could withdraw £32,160 from your Isa.
• Tax is £5,227, leaving you £98,029 to spend on essentials and leisure.

A complete breakdown can be found by clicking on the + sign below.

Please remember that past performance is not a guide to future performance and may not be repeated.

Source: Cazenove Capital. For information purposes only. The material is not intended to provide advice of any kind. Information herein is believed to be reliable but Schroders does not warrant its completeness or accuracy. 

This content is provided for information and discussion purposes only. It is not intended to be professional financial advice and should not be the sole basis for your investment or tax planning decisions. Under no circumstances does this information represent a recommendation to buy or sell securities.

Statements concerning taxation are based on our understanding of the taxation law in force at the time of publication. The levels and bases of, and reliefs from, taxation may change. You should obtain professional advice on taxation where appropriate before proceeding with any investment.