This article is part of our Guide to Maximising Your Pension, helping investors build up the maximum possible pension pot – and turn it into the maximum possible retirement income.
Emma Wall: Hello and welcome to the Morningstar Series, 'Ask the Expert'. I'm Emma Wall and I'm joined today by Lydia Fearn of Redington.
Hi, Lydia.
Lydia Fearn: Hello.
Wall: So we are running a guide to retirement, a guide to maximizing you pension saving this week and today we are focusing on that first part of the journey. Those peoples' in their 20s and 30s who perhaps are saving into pension for the first time, thanks to auto enrollment. Firstly, I thought I'd ask you why is it so important for this age group to start now.
Fearn: Well, it's absolutely critical they start as early as possible and as much as they can, because the sooner they start saving, the more it will grow over the longer term. For this group, the likelihood of them having defined-benefit pension is probably quite small. So actually this amount, this money they are putting away is going to deliver their income for their future. So when they retire, they will be able to have a reasonable and comfortable retirement. So it's very important that however painful it is to start saving, they start putting that money away on a regular basis, get used to it and budget outside for the rest of the money that they have on income.
Wall: That's one of the thing that auto enrollment has been praised for doing, sort of tapping into this behavior science, the inertia part which is we haven't had to opt in, people in their 20s and 30s are seeing only a small amount of pre-tax income going into a long-term savings vehicle. At the moment, that minimum contribution is very manageable, it's very small. But in two years' time, this minimum contribution will go up to 4%. And its perhaps this age group which have of course lots of other financial challenges, you know they are not earning as much as they may do in a couple of decades time, they may be saving for house, they may be starting family. Is this age group that are most at risk of opting out when they see that rise, aren't they?
Fearn: That's right. And I would encourage them not to opt out. I would encourage them to think about how that – there is going to have the rises that will happen and to budget around that. So if they, for example, have a pay rise or they move jobs or something like that, so maybe then reset their contribution level at a slightly high level. Ideally, they should be targeting in total around 12% to 15% and that may feel quite – like quite a lot of money. But don't forget you’ve got some extra contribution from the government as the tax breaks that you get when you put in to pension and also your employer is putting in money as well.
So as a combined amount, it might be actually quite achievable. But getting used to putting that amount of money away as early as possible and maybe make in line with your pay rises might make it feel a little less onerous and less scary. But again, it goes back to, it's incredibly important to save that sort of money for longer term, because at the end of the day you'll have your state pension. There might not be anything else. You need to make sure you've got that nest egg when you come to retirement.
Wall: And that 12% to 15% as you say if you think 12% to 15% of my annual income needs to go into pension that seems a like a lot. But it's not just you contributing to a pension, is it? It's your one of three contributors to workplace pension.
Fearn: Absolutely and I did some analysis couple of years ago, we were looking at the 8% and how much extra that means on top of my combined 8% with a 4% from myself. It actually only means maybe an extra £50 a month or something like that. So actually from a quantum it's not a huge amount but I absolutely understand that it's very difficult to balance that against all the other financial issues that are going on. But it's getting that mindset saying actually what I am doing is putting this – locking this away for my future and when I get to 55, 65, I can decide what to do with that money.
Wall: Just briefly then, there is one distraction on the horizon which is this new Lifetime ISA that's been launched by the Chancellor in this year's budget. This is a new kind of savings vehicle which has had a mixed response from industry because some people are saying it will detract from the importance of saving into a pension. What you say to that?
Fearn: I think it needs to be taken with all the savings vehicles we've got. So we have the pension scheme obviously which people should definitely look at, they have got employer contributions, they have got tax contribution. So really look at that as a way to save their future you've got ISAs now, say cash ISAs, you've got help to buy ISAs, stocks and shares ISAs. And the Lifetime ISA is a really nice and neat and easy savings vehicle for people to understand. But it should be used in conjunction with other savings vehicles.
So make the most out of the pension contributions you get and if you can make the most out of the ISA contributions, but it has to be balanced it depends what you are using it for as well. So if you want to use it to purchase a house you might feel actually short term cash investments are the right thing to do. If it is something you are going to think about for longer term really think about the investment strategy around it is important you get it invested over the longer term because you need that investment growth. But I would definitely encourage individuals to look at the benefits of the pension scheme against the potential benefits of Lifetime ISA and make sure they are making the right decisions.
Wall: Lydia, thank you very much.
Fearn: No problem, thank you.
Wall: This is Emma Wall for Morningstar. Thank you for watching.
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