Pensions. An Absurd Play. UK Advice Services.
Mothers + Pensions + Sons = Arguments in Alien Languages
Me: Money money money. Money. Yak. Yakity yak yak's milk smoking budget budget budget utilities after tax gym
Mum: Are you saying you don't want me to keep fit at the gym?
Me: No. I'm trying to assess must-have expenses like water bills to possibly variable expenses like gyms so I can match super reliable income money money money smoking
Mum: That's why I go to the gym to be healthy...
Me: In this case the upside to smoking is that there are better annuity rates so death death death
Mum: You saying I'm going to die soon? You know the genes in my family...
Me: Yak's milk.
Mum. Eat your food up
Me. Muuuuuuuuum.
(O. What are Dad and Grandma talking about? A: Pensions. O: Do pensions make people angry? S: Let's go for Trains.)
We make a Pinter play seem positively non-absurd.
This area is complex enough that it has taken me days to reach a place where I can make some sense of it. I'm still having to convince that a proper annual expense budget is going to be needed so I can try and match reliable income to it, under uncertain assumptions of size of pot and also ever changing UK pension rules (pension drawdown) and tax rules (dividend tax allowance, savings tax allowance)
Given the life expectancy forecasts (all in the up) and my new found understanding (especially of the human decision making part) I'm now putting pensions alongside healthcare, climate change, and (forced) migration as serious and systemic problems which partly due to their long term nature and complexity are poorly dealt with by humans overall.
Many would point to using an IFA (independent financial adviser) at this point. However in my view, in the UK, I would recommend you first contact these two government sponsored services.
The Money Advice Service which has a good (if somewhat too balanced, in my view) website as well as offering phone advice and a webchat advice.
The Pension Wise service which will give you 45 to 60 minutes of advice (if you are over 50 and in a money purchase defined contribution scheme.)
You should also find out what your State Pension is likely to pay you.
Furthermore, before contacting these two services you should also fill out this money check guide (from Money Advice Service) and to be ruthlessly honest on it (eg don't hide your cigarette expense from it). That should help the majority of people, if after that you still need advice then look up an IFA which both services can direct you towards as well, although it is likely word of mouth on that work might better.
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A theoretical case study. Goal to match the approx gross £28,000 UK Median wage. This is approx £22,000 after tax. Purely, back of the envelope, rough calculations (mistakes quite probably made!) There is an BBC News / Actuary calculation here for various type of ages and income, though it puts money only into an annuity at the end.
The State Pension is worth £8,300 pa. You have a £11,500 personal tax allowance. We will secure another £3,000 in yearly income via an annuity. For simplicity, we will take this straight.
For the typical 65 year old this will take a pot of about £60,000 (gender, smoker, guarantees, inflation links will all vary that).
We now need to generate another £11,000 after tax. In the UK, you do not pay tax on the first £5,000 in dividends (this may change, but it seems likely a reasonable idea for governments to keep this). Several equity income type funds will pay approx 5p in the £1 while attempting to maintain capital, this might slightly draw down over time, but with some skill (or luck) could even appreciate. This would take approx £100,000 if you had it in savings outside your pension pot, or used some of the lump sum tax free amount (25% of pot) on taking your pension. We are now at after tax £16,000 (and we've used £60,000 buying the annuity, and have £100,000 in equity income funds).
We need another £6,000 after tax. Here's where it becomes trickier. One of the most things efficient things to do here is to earn this either in an ISA which is tax free, or with some interest income (where you also have a £5,000 tax allowance limit). So if you happened to have another £120,000 sitting in an ISA, you are approximately done and reached £22,000 (although there could be some variation as money tied up in a equity income fund, and as we all know the equities can go up and down, but hopefully they can stick to near the right yield for you) Else, if you have £120,000 sitting in a pension pot you can also get close with a mix of drawdown and income, but your pot would slowly erode over time so it might not feel comfortable. Or you can buy an annuity, but although £120,000 would buy £6,000 or so, this would be pre-tax and not inflation proof. A pot of £200,000 would be needed to feel comfortable and if turned into annuity would also get you close to a 3% pa escalation on about £6,000.
So that's quite a lot: £60,000 spent on an annuity; £100,000 in equity income funds; then between £120,000 to £240,000 more needed in a vehicle either ISA or pension pot in drawdown, the £240,000 for the most comfort, the £120,000 being in the realms of possibility but not comfortable. Suggesting a min figure of about £300,000 in a mix of savings/pensions at 65 now (2017) to generate around £22,000 in after tax income. These figures will likely only increase with time.