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Your 3-step guide to making up the State Pension shortfall

According to the Office for National Statistics, the annual average spending for a one-person retired household is currently £13,265. Problematically, those qualifying for the new state pension can expect to receive just £8,767.20 per year — a third less.

That’s why yesterday (August 29) has become known as State Pensions Shortfall Day, signifying when an average retiree’s pension would theoretically run out if they were handed the full amount on January 1.

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If the prospect of regular beans on toast in your golden years fills you with dread then you’re going to need to do something about it while there’s still time. 

1. Work out YOUR shortfall

Of course, the figures provided by the ONS are intended only as a guide — the actual amount of money we’ll need in retirement will vary from person to person and take into account everything from hobbies to bills to health.

So, to get a better grip on how big your shortfall would be — and, consequently, how much you need to save — you first need to estimate what you think your likely spend is in retirement. Sure, this will require a bit of guesswork if you’re still decades away from swapping the rat race for the golf course, but it’s still a perfectly valid exercise, if only to highlight just how important it is to begin tucking money away. 

2. Get a private pension

Having come up with a ballpark figure, you’ll then need to get saving into a private pension, either through your employer(s) or off your own back. 

Doing the latter would necessitate opening a Self Invested Personal Pension (SIPP). This kind of account can be set up at any age. There’s even a junior version for those contemplating retirement savings for their children. 

Why not just use a Stocks and Shares ISA“, you ask? Well, as great as this kind of account is, it doesn’t have quite the same benefits that you get with a SIPP such as the ability to pay in up to £40,000 in any one tax year (double the £20,000 ISA limit).

The biggest plus, however, is the tax relief on offer. As an example, a basic-rate taxpayer placing £100 in their SIPP will receive an extra 25% bonus from the government, bringing their actual cash amount to £125. Over the years, that will really add up. 

3. Keep it simple

Having started to save into a pension to address any planned shortfall, you then invest that cash. For those who have little interest in the markets, simplicity is key. 

If we’re talking about individual companies, it can make a lot of sense to buy a diversified portfolio of large-cap stocks that pay decent (and sustainable) dividends to their owners. These cash returns can then be re-invested back into the market to compound over time and then used to supplement the State Pension on retirement.

If this sounds too risky, then investing passively (i.e. tracking a market rather than paying an experienced but ultimately fallible human fund manager) might be the way to go.

One of the easiest ways of doing this is to buy an exchange-traded fund that invests in thousands of companies all around the globe. An alternative would be to pick a fund that focuses on generating a high yield. The diversified iShares FTSE UK Dividend Plus fund, for example, yields 7.2% at the moment.

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Paul Summers 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.