40? It’s Not Too Late To Rescue Your Retirement

retirementHow much do you need to live on in retirement? Research released this week highlighted an ‘optimum’ retirement income of between £15,000 and £20,000 a year, including the state pension.

According to the National Employment Savings Trust, 43% of people with retirement earnings in that range felt financially comfortable. Below the £15,000 figure, just 24% felt comfortable. And while earnings above £20,000 helped people to feel comfortable and secure, it seemed that earnings above £40,000 made no difference.

The problem? With the revised ‘flat-rate’ state pension providing an expected income of around £7,500 when it comes into force next year, huge numbers of people will struggle to reach £15,000 — never mind £20,000 or £40,000.

Impoverished old age

Greater longevity compounds the problem. According to the Office for National Statistics, a man aged 65 can now expect to live for 18.2 years, while a 65 year old woman can expect a further 20.7 years.

And according to the Department for Work and Pensions, nearly one in five of us will live to see our 100th birthday.

So if you’re impoverished and financially stressed in retirement, the bad news is that you’re going to feel miserable for longer.

Which, if you’re approaching your forties and starting to think about these issues, is a worrying prospect.

Forget the packed lunch

To my mind, the doubtless well-meant suggestions from the National Employment Savings Trust don’t really help.

It reckons that if a 30-year old replaced a £12 takeaway with a home-cooked meal once a week, they could build up a pension pot of £50,000. And taking a packed lunch to work could build up a pot of £63,000.

It’s a start, certainly. But I think it’s the wrong answer, to the wrong question.

Because for many people, the problem isn’t one of saving — it’s one of investing.

Saving? We are saving!

During the period 1992-2008, the UK’s savings ratio — the proportion of our overall incomes that we save — fell to an all-time low of 2%.

But since then, it’s risen sharply. With the end of easy credit, and the end of the rising house price ‘feel good factor’, individuals have raised their savings ratio to around 8% — a quadrupling, in short.

The government, too, has woken up to people’s preference for flexibility in retirement savings. Rather than locking money away in a formal pension scheme such as a Self-Invested Personal Pension (SIPP), many of us prefer to save in ISAs — where, in an emergency, we can get at some of our savings if we need to.

In the 2012/13 tax year, for instance, HMRC figures show that some 14.6 million people invested in an ISA.

Poor returns

So to my mind, the issue isn’t solely about getting people to save for retirement.  

It’s making sure that those savings do their job — building up a decent-sized pension pot, one that can then be relied upon to provide the required cushion in retirement.

Better financial education would help. Of those 14.6 million ISAs, for instance, four out of five were Cash ISAs. At a time when the Bank of England’s Bank Rate is at a 320-year historic low, this seems a trifle optimistic.

And of the money that was put into Stock and Shares ISAs, a high proportion went into investment funds — some £2.3 billion worth in 2013/14, up a hefty £1 billion over the previous year.

Some of these will be perfectly sensible, low-cost funds such as index trackers, of course. But many will also be high-charging funds, where the manager leads a champagne lifestyle for delivering a performance that’s no better than a tracker.

New era

The good news: in the years ahead — the very years in which a 40-something needs to be building a pension pot — the rules have changed.

Prior to the 2014 Budget, the aim was to build a pension pot, and then buy an annuity that would deliver an income.

Now, there’s no need to buy an annuity. And if — like me — you opt to build that flow of income directly, from dividends, there’s no need to pay a fund manager’s fancy fees, either.

Ditch the fund manager

So save into a Stocks and Shares ISA — but invest directly in shares, not funds. These shares will deliver an income, now and in retirement, that is then free from any further tax — without paying fees to fund managers.

But which shares to choose?

It's a good question. So if you're contemplating this route to retirement, I'd start here -- with one of The Motley Fool's latest free wealth reports, How To Create Dividends For Life. It's completely free and without obligation, so to get your copy today, click here now.