Your 40s are a perfect time to start thinking ahead and planning for retirement.
Your 40s are often a busy time. You may be focused on forging ahead in your career and juggling a busy family life with children and all the costs that involves. However, now is also a critical time to take stock of your pensions.
1) Check your state pension
The bedrock of your retirement income is likely to be the state pension, and you can check your entitlement here. The state pension might seem relatively small but it is likely to take on greater significance during retirement because it is both guaranteed by the government and benefits from annual uplifts.
Hopefully, you'll still have many years to build up enough National Insurance payments: you'll need 35 years to achieve a full state pension. Even if you've taken time out, periods of statutory sick pay or maternity, or eligibility for jobseeker’s allowance often give you a free national insurance credit.
It's worth keeping an eye on your National Insurance Contributions, or NICs, as you can top up your state pension if you have not paid sufficient years of National Insurance by buying Class 3 credits, which cost £15.85 for a week or £824.20 for a year. Each qualifying year gives 1/35th of the full state pension amount.
At present, you buy credits to make up for NI shortfalls going back to 2006, but from 5 April next year you will only be able to fill in gaps for the past six tax years. It will often pay to make voluntary contributions for these earlier years while you can, as they will be cheaper than buying years later.
2) Check your state pension and private pension age
The age you can collect your state pension is gradually increasing for men and women, and will reach age 67 by 2028, but it is under review and could change again.
You can check your pension age based on current legislation here. “However, beware. Although the timetable for moving to age 67 by 2028 is probably fixed, the move to age 68 will almost certainly be sooner than implied by current legislation (2046); current government policy is to get to 68 by 2039, but a five-yearly review is about to be completed and we should hear in the new year whether 68 will be brought forward,” says Steve Webb, a former pensions minister and currently partner at LCP.
“This is important not only for state pensions, but if you have private pensions that you planned to access well before state pension age. You may find that the ‘normal minimum pension age’ – the age at which you can exercise your pension freedoms to take cash and so on - which is currently 55, goes up to 58 when state pension age goes up to 68; and the normal minimum pension age (NMPA) will rise to 57 in most cases from 6 April 2028, when state pension age rises to 67.”
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Furthermore, most UK occupational pension schemes have 65 as their “default” retirement age (i.e. the age if members don’t select their own choice), which will be different to most peoples’ state pension age, leaving a funding gap.
3) Consider how much you need in retirement
The Pensions and Lifetime Savings Association (PLSA) suggests that, as an individual, for a minimum standard of living, you’ll need £12,800 of income per annum at today’s rates. For a moderate standard of living, you’ll need £23,300 and for a comfortable retirement, you’ll need £37,300.
These figures are all net of tax and assume you will not be paying a mortgage or rent in retirement. “It’s not too late to save in your 40s,” says Rona Train, a partner at Hymans Robertson. “Increasing pension contributions in your 40s and 50s, or perhaps when you become an empty-nester, can still have a big impact, especially if you’re getting matching contributions from your employer.”
4) Think about employment as well as pensions
“Is the job you are doing at 45-50 one you could still be doing at 65-70?” asks Webb. “If not, could you be doing something now to start re-training/re-skilling so that you can have a later-life career switch? The best retirement strategy is to save for as long as you can, so if you are able to keep working longer this gives you a bigger pension pot when you do retire and fewer years over which to spread it. But many people find they cannot keep working if they are only looking at doing the physically demanding or stressful job they have always done. Integrating financial planning with career planning makes sense.”
5) Don’t play it too safe
The two decades before retirement is a time when good investment performance can make a huge difference to your pension pot because your fund is likely to have already built up, and therefore any profits will be based on a larger fund. Missing out on upside has a big impact as any gains are compounded over time.
Many people, particularly in workplace schemes, have their pension pots invested in funds that include up to 60% bonds and cash, which will not begin to keep pace with inflation, let alone at its current rate of over 10%. Recent research by IFA Magazine suggests that an estimated four million workers under 40 are in low-risk pensions. However, if you’ve got 20 years ahead of you before you retire, this is a long period for investment volatility to smooth itself out.
6) Keep your portfolio diversified
Keeping your portfolio well diversified has been difficult in recent years as returns for higher-risk assets such as equities and low-risk assets such as bonds have been correlated, which was never supposed to happen. However, you still need to diversify and can achieve this by buying uncorrelated asset classes such as infrastructure, property, commodities and precious metals in place of some of the bond allocation.
You might also consider absolute return funds such as LF Ruffer Diversified Return fund or Janus Henderson Absolute Return fund, which aim to make a positive return regardless of the direction of the broad stock market.
7) Remember to rebalance your portfolio
After you’ve carefully constructed your portfolio, it might be tempting to assume that all the work is done. However, in a diversified portfolio, assets perform differently, for example, if stock prices fall then typically another of your assets, such as gold, will increase in value. Equities and even whole sectors fluctuate as they go in or out of favour because of customer demand, regulatory changes or geopolitical events.
Technology, for example, had a great run during the pandemic. However, a period of outperformance in an asset can result in a disproportionately high weighting in your portfolio, raising the risk of short-term losses should that asset fall back to normal levels. One solution is to allocate new cash contributions to the underperforming asset classes to redress the balance in the portfolio as this allows you to leave your winning assets intact.
However, “don’t rush to act after markets have already moved”, warns Baroness Ros Altmann, a former pensions minister. “Do try to contribute regularly to benefit from pound-cost averaging and invest through market cycles rather than trying to 'time' the markets.”
8) Plan as a couple but also plan for the worst
If you're in a relationship, it often makes sense to plan as a couple. For example, could one of you build up more private pension savings if the other has already hit annual or lifetime limits?
However, it's also worth thinking about the worst-case scenario. Divorce can wreak havoc on your finances. In particular, divorced women retire with half the pension wealth of other women (and just 10% of men). Women are particularly badly hit because they tend to focus on the house, and care arrangements for children during the divorce process, and often have caring responsibilities meaning they can only work part time.
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If you face divorce, consider requesting a pension-sharing order, which sets out how much of your partner’s pension you are entitled to. Fewer than two in 10 divorces in the UK request to have a pension-sharing order, research by NOW: Pensions has revealed.
“Similarly, think about what would happen if one partner died,” says Webb. “In the past it was assumed that, for example, there would be a big state pension uplift for a married woman who became a widow, but that doesn’t happen in the new state pension system; so what would happen if, say, the partner with the higher pension died? What if they have a state pension that dies with them and a single life annuity, which dies with them?”
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