When Should You Start Saving Money for Retirement?
Nobody gets younger as time passes. So, it’s a safe bet to assume that one day you will grow old and retire. And while it’s tempting to put off thinking about it (especially if you’re in your twenties), it’s best not to.
The thing is, the quality of your life after retirement will depend on the financial decisions you make now. Will you put aside enough money to enjoy your life? Or will you scrape by? That depends on when you start saving!
Those are real concerns, and they are warranted. Yet, if you want to live your life after retirement with dignity (and enjoy it, too), coming up with a plan now is a must. So, let’s break down why, when, and how you should start saving for retirement.
How Does the UK Retirement System Work?
First, you should know: yes, there is a basic State Pension in the UK (although it’s not without its flaws). It’s financed by the National Insurance Fund. So, the contributions you pay out of your wage finance, in part, the state pension.
Then, there’s the auto-enrolment pension program. Every employer has to offer one and enrol all of its employees over 22 into it by default.
Under this program, you transfer a share of your qualifying earnings to a pension scheme, and your employer complements it. The total contribution minimum is 8%, and the employer’s share in it has to be at least 3%. You can access the money after you turn 55. You can also opt out if you want.
You’re also free to save up for retirement yourself. You can open a savings account for this purpose, for example. Or, you can invest it to build wealth – but keep in mind that any investment has some risk to it.
Why Save Money for Retirement at All?
Why save money if the government is supposed to pay you a pension once you reach retirement age? Well, the answer lies in numbers. At the moment, a retiree receives only £141.85 per week (£185.10 for those who retired after April 2016) in the basic State Pension. That amounts to just £567.4 (£740.4) per month.
How would it compare with your regular income throughout life? Let’s take the current average working week and minimum wage regulations in the UK. Under those, you would get £380 per week if you work 40 hours and are over the age of 23. That means the current pension is more than twice lower than salaries!
All in all, with the current state of things, the state Basic Pension is very unlikely to cover your needs when you retire.
Yes, on the one hand, you’ll have paid off your mortgage by then and your children will have become adults. So, some expenses will disappear. But consider the fixed expenses (groceries, bills, etc.) and others that may arise, like caregiving services and healthcare costs.
So, When Should You Start Saving?
The short answer is “now.” The sooner you start, the better. Why? You can make smaller contributions if you have more time ahead of you, for one. Plus, depending on the saving method you choose, you’ll have more time for the compounding interest to grow your wealth.
Let’s break down both of these reasons. Imagine you want to have an additional £100,000 to complement the basic State Pension. If you start working towards this goal when you’re 25, you’ll have 40 years to achieve it. Your average monthly contribution will have to be £208. If you start at 45, though, you’ll have to set aside double that every month – £416.
As for the compounding interest, think about it this way. Imagine you open a savings account with £1,000 when you’re 25, with an annual interest rate of 2.5%. If you just let it sit there with the interest you earn, after 40 years, you’ll more than double your money – you’ll have £2,685.
If you do the same thing but at 45 instead, your money won’t have as much time to grow. Two decades later, you’ll have only £1,638. This is a (somewhat simplified) example of compound interest in practice.
How Much Should You Set Aside for Retirement?
Will that auto-enrolment pension scheme be enough for you at its minimum contribution level? Or should you increase your contribution?
The answers would depend on your final financial goal. But it’s impossible to set it in raw numbers – no one knows what the future holds and how expensive life will be when you retire.
So, it’s better to set a goal to put aside a share of your pay instead. What should that share be? A good rule of thumb is the age you started saving for retirement divided by two. I.e., if you started at 30, that would be 15%.
If you can’t afford to set aside this much now, still add savings to your monthly budget and set aside as much as you can. Then, you can use the pay rise trick: put aside a quarter of the extra money you get after a raise.
3 Smart Ways to Prepare for Retirement Financially
So, let’s assume you are ready to start saving for retirement. How should you do it, exactly, to have peace of mind?
The short answer is, avoid high-risk investments at all costs. They draw you in with a potential high gain, but your losses can be as tremendous as gains. So, in other words, cryptocurrencies, NFTs, and volatile stocks aren’t a good option for you.
Instead, you can choose one out of these three paths for saving money – or, ideally, combine them.
Auto-Enrolment Pension Scheme
Check how much you and your employer contribute to it – and whether it aligns with your savings goal. If it’s below your objective, increase your contribution or put money aside otherwise.
If you’re between 18 and 39, you can open this particular type of savings account (LISA) with as little money as you manage to save up. With it, you can save up to £4,000 a year, and the government will add 25% of what you save as a bonus.
Self-Invested Personal Pensions (SIPPs)
Dubbed a DIY pension (SIPP), this is a suitable option for you if you want to invest your retirement savings to grow them in the meantime. Keep in mind, however, that there’s no such thing as a zero-risk investment!
To sum up, the earlier you start saving, the better. You’ll need those savings later on since the basic State Pension won’t be enough to live your life fully. And you have three options to choose from when it comes to the “how” part: auto-enrolment pension schemes, lifetime ISAs, and self-invested personal pensions (SIPPs).
But before you close the tab, let’s leave you with three additional tips on approaching this matter:
- Don’t put all of your eggs in one basket. Or, in other words, diversify your savings, both in terms of which institutions you entrust with them and savings options themselves.
- Remember to factor in any taxes and fees you have to pay on your pension and/or gains from the interest rate.
- Keep inflation in mind: the interest rate you earn on your savings should at least be equal to the inflation rate. If it’s below, you’ll essentially be losing some of your wealth.