“I’d like to contribute by 15 Mar but there may be unforeseeable circumstances which prevent me“ [ Recently seen note from an Actuary]

“Et tu Brute”: We can all suffer from reluctance to contribute whether or not it's the Ides of March which leads to unforeseen circumstances. Sometimes this reluctance can be fatal. 

For how many people does OAP stand for Old Age Poverty?  Old Age Poverty may not be written on many death certificates – but just look at the death statistics during cold weather.  Even if the story or pensioners are buying 5p hardback books to save money on fuel is false ( http://illandancient.blogspot.com/2010/01/this-pensioners-burning-books-story.html) it was widely reported as the sentiment is real - what will it be today: Heat or Eat ?

So you’d think that there would be major campaigns and information on the importance of saving for retirement and how much money you should be saving?  Don’t die of Ignorance.

 And yet, and yet … I have been an Actuary for nearly 20 years.  We still have very senior members of the pension industry telling apocryphal stories of people saving £10 per month expecting a comfortable pension – addressing the pensions' audience with wry smiles and metaphorical hand wringing.

THIS IS SHAMEFUL.  "EVERYONE" KNOWS IT'S NONSENSE.  

THE LEVEL OF CONTRIBUTIONS IS THE SINGLE MOST IMPORTANT FACTOR IN DETERMINING LEVELS OF PENSIONS PAID.

POVERTY FROM DEFINED CONTRIBUTIONS PLANS WILL BECOME THE NORM IF WE DON’T GET THIS RIGHT

WORKING IN THE PENSIONS INDUSTRY MEANS THAT IT IS YOUR FAULT IF YOU CAN'T GET THIS ACROSS.

CALLING ALL PENSIONS ACTUARIES:  Make 2010 the last year anyone can make that statement about pension contributions.  Get mad.  Before the profession's tagline gets extended …. making financial sense of the future  (... but not in a way you’d understand).

My attempt is below.  But please actuaries or anyone else in the industry do come and do better !

So how much should a 30 year old contribute for a good pension ?   

£300 per month if you are on £24,000pa ( £70 pw for £460 pw)

Why?

Well, we can make this quite simple.    There is one cheat in the analysis below “the magic of investment” hides some complications but I will address these at the end.

We save for the pension whilst we are working. We spend the pension whilst we are retired.

So if we work for 40 years,  and retire for 20 years then we have 2 years of work savings for each year of retirement. “Doubling” the amount we save.

We can also invest the money we are saving.  In round numbers, keeping the value of money the same (inflation adjustment) we can double the amount through investment. :  the “magic of investment”. [ Techies see footnote below.]

Putting these together : the pension we get will be  4 times what we save.

A good pension is considered to be 60% of salary which means you would need to save 60/4 = 15% of salary or £300 per month if you earn £24,000.

This can be considered the 40/20/15 pension plan

Is that realistic ?   Well, it would mean  a 30 year old works until 70 and retires until death 90.  As an average case that looks realistic. 

 Not the example dummy , the amount of money , I can’t afford that !!

Well, can you afford not too ?  It is interesting, 15% is often quoted as the target rate for pension provision.

You can’t change the maths: but you can:

Ok, let's have another go :

• Work for 50 years
• Retire for 20 years

2.5 years work, same doubling magic of investment : pension 5 times what you save  = 50/5 = 10% of salary or £200 per month

This is the 50/20/10 pension plan.

Nice idea – realistic ?  A 20 year old, working to 70 and retiring until 90.  That works.

Wow, 10% vs 15% of salary… so that’s why they told us to start at 20.  Shame its too late now !!

But I’m not 20 what can I do !

Ok, lets start again from 30 but work to 75 

• Work for 45 years
•  Retire for 15 years

3 years work for each year retired, still doubling, 6 times what you save =  50/6 = 8.3% of salary each year. ie  £150 pm of £24,000 pa salary

This is 45/15/8 pension plan. 

IF YOU ARE A 30 YEAR OLD SAVING 8% of YOUR SALARY INTO A PENSION THEN:

• Retire at 70 for a pension of 32%  ( if you can live of a third of current salary)
• Work until 75 for a pension of 50% ( fairly “tight” for most people) 

Obviously, if you were only saving half these amounts you would only expect half these level of pensions (wouldn't you?).

If you are now 30, and happy to work to 75 then 8% of your salary might just work... but comfortable retirement is much closer to 15%.

That’s the maths: get over it !

If you are older than 30, then we can apply the same approach to calculate the pension you will receive at a given retirement age :

• What percentage of your salary are you saving? 
• How many years will you be working until retirement?
• How long will you retire ?  ( assume death at 90 as an average)

The percentage of salary times the ratio working to retire times by the “magic of investing” gives you your target pension.

Unfortunately, if you are older the “magic of investment” is not quite as strong ( it doesn’t have as long to work).  There is more in the footnote on “magic of investing” but in broad terms it goes down by 0.2 each 10 years older you start

So what Pension Plan are you on ?  … and those in your pension schemes ?

For another day

When we start seeing the amounts involved then you realise it is not only education on amount s- its is also a question of helping people achieve these levels of consistent savings.  As we move from DB to DC environment we can just say you need to put 15% into a pension we need to show them how to do it.

 For another day but to help note :

1.       It’s gross not net.  The money out of your pay packet would be much lower : £50 vs £70

2.     Your employer might help with some contributions. Take advantage of this !

3.       Money management : eliminating “capacenses”

• Starbucks a day = £20 pw
• Make vs buy sandwiches at lunch = £20 pw
• Wash the car = £10 pw

[Ok, an extreme for illustration. Unrealistic such easy saving for everyone… but could be significant for many]

4.       Buy your next car

• Car loans at 10% on a £12,000 car.
• £1,200 per year or £100 per week “lost” money

5.       Save half of your next pay rise ….

Many ways to do it: but if you are serious about making a genuine difference then you need to both educate on amounts and facilitate on action.

In conclusion

I hope this can be helpful to explain the order of magnitudes for saving. I’m sure it can be improve in presentation and delivery.  What pension plan are you on?

But please consider it if it is helpful.

Please do something better if not.

_____________________________

Brief footnote on the “magic of investing”

The real crux of the simplification is equating “magic of investing” to doubling.

How reasonable is this ?  Well again simplifying,  someone with 60 years to invest, assume average investment of 30 years – implies 2.3% which would be a real return to adjust for inflation and net all expenses..

That’s no longer a guaranteed rate ( at least not in sterling) but I feel is a reasonable target.

If you want to decide 1.3% real return is more realistic ( or whatever) then it would be the magic of “1.5” times-ing.

If you only assume a real yield (no extra return) is possible then the “magic” goes away and its just the ratio of working to saving.

The other aspect is variability of investment returns. Personally I would feel 1.5 to 3 times should capture most of the variability of a sensibly organised investment approach.  Much outside those ranges has a fairly significant impact on the outcome – and questions if we have the right investment approach or framework.

Finally, the other scare is usually additional longevity. Actually this is fairly simple to deal with – just increase the target retirement date maintaining  the ratio of working to retired life given the new expected life.