The State Pension currently stands at £164.35 per week. This means that an individual’s annual income from the it alone is just £8,546. Given the continued rise in the cost of living across the UK, this is unlikely to be sufficient for the majority of people to live comfortably in retirement.
And since life expectancy has increased in recent years so that people spend up to a third of their adult lives in retirement, obtaining a sufficient income in older age is arguably more important than ever.
The most common way of supplementing the State Pension is through a private pension scheme. With defined benefit schemes becoming less generous and unlikely to be around for new entrants in the coming years, the reality is that people will need to make their own arrangements in order to boost their incomes.
While there are numerous means of doing so, the FTSE 100 offers a relatively simple method of generating impressive returns in the long run. At the present time, it offers a dividend yield of around 3.8%. Assuming an individual invests in the index and then uses the dividends as their income in retirement (thus preserving the capital they have invested in the FTSE 100), they would require a nest egg of £225,000 in order to get double their State Pension amount each year. In other words, a nest egg of £225,000 at retirement would currently provide dividend income of £8,546 per year.
While such an amount may seem a lot, the FTSE 100 could be an easier means of generating a sizeable nest egg by the time of retirement than many people realise. Historically, it has offered an annual total return which is in the high-single digits. Assuming a 7% annual total return, an individual investing £100 per month over the course of 40 years could have a nest egg of around £240,000 by the time they retire. This should be enough to more than double the State Pension income in retirement without eating into the capital.
Clearly, though, it is possible for an investor to beat the FTSE 100’s returns. One method of doing so could be to buy undervalued shares which have bright long-term futures. At the present time, for example, sectors such as banking and retail are not especially popular among investors. This could create a long-term investing opportunity. Similarly, investing in the FTSE 250 or in smaller companies could lead to higher returns. For investors with long-term time horizons, the volatility of such shares may not pose a major threat to their retirement plans.
With an ageing population that is living longer, it seems likely that the State Pension will become less affordable over the coming years. Combined with the reduction in availability of defined benefit pension schemes, this means that individuals will need to make their own arrangements should they wish to enjoy a higher retirement income than that provided by the State Pension. With the FTSE 100 offering relatively impressive returns, it could be a good place to invest modest amounts on a regular basis over the long run.
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Peter Stephens has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.