FOOL'S EYE VIEW
Calculate The Value Of Your Pension

By James Carlisle
November 4, 2002

It's been said about a million times that there's a huge gap between what people are saving and what they'll need for retirement, but there rarely seems to be much help in actually working out how much we should be saving. The Motley Fool has tried to cover the issue before, and we have some calculators to help, but it's great to see a new pension calculator, at www.pensioncalculator.org.uk, appear on the Web courtesy of the Association of British Insurers and the Financial Services Authority (FSA). The calculator obviously can't provide you with definitive numbers (nobody can) and it has one or two shortcomings, but it will serve its purpose if it demonstrates to a few people how hard they need to save and how soon they need to get started.

So go and have a play with it!

Throwing some of my own numbers at the calculator suggests that a 30 year old (I can dream) retiring at 65 (I can dream of that too) will get a weekly income of about £74 for every £100 per month that they put into a pension. That is in terms of today's money. So £50 per month might generate a weekly income of £37 (half of £74) and £200 per month might generate a weekly income of £148 (twice £74).

If, however, you started the pension at 20, then you'd stand to get a weekly income of more like £115 per £100 saved each month. If you started your pension at the age of 40, however, then you'd be looking at a retirement income of just £44 per week for each £100 saved each month.

Shortcomings

As ever, though, there are a few of shortcomings. The main problem is that the calculator only estimates the income you stand to get on pension contributions from now on, so it doesn't show what you stand to get from any pension fund that you've already built up. This is a major failing, since the most important thing about doing this type of lifetime financial planning, where you're having to make some very wild assumptions, is to keep redoing it. That way, over the years, you should "home in" on the right amounts. For example, if your investment growth is worse than expected, redoing the sums should tell you that you need to save harder to make up the difference. (The Fool's calculators will let you do this, but you have to do more work yourself to make it model a pension.)

There are also, inevitably, some issues with the assumptions themselves. The most important assumptions that the calculator makes are the annuity rate, which determines how much income your pension pot will buy you when you retire, and the investment return that you'll get over the years. It looks like the calculator is assuming that annuity rates will be about the same when you retire as they are now. That would be the most sensible approach (given the current flattish yield curve) but it does mean that the calculator will need to be updated as annuity rates change. It also means that you'll need to redo your sums periodically to make sure you're still saving the right amount, although you should anyway.

The calculator starts with an investment return of 7% per year. However, it takes account of inflation of 2.5% per annum to provide you with an estimate of your future income in terms of today's money and it also takes away 1% a year for your costs. This level of costs is in line with the maximum that a stakeholder pension can charge. So the assumption is basically for 3.5% growth after inflation and after costs. That looks reasonably conservative compared to an equivalent figure of just over 5% from shares historically (deducting 1% charges from the real return of just over 6% per annum in the CSFB equity gilt study), but then it pays to be conservative with this sort of thing.

If you keep redoing your sums, then being conservative might mean that you can slack off a little on your saving later on, but it's far better to do that than to start too slowly and have to speed up later.

So there are a few shortcomings, but if the calculator causes a few young twentysomethings to start saving now, instead of waiting until their thirties, then it will have served its purpose. So go and have a play with it, Fool, and then get saving!

More: The Fool's Pension Centre; the Fool's ISA Centre