Providing for your retirement

You may only just have started being self employed, or running your own business. So when do you start to think about retirement? The answer is – now!

It is never too early to start providing for your retirement. Any delay severely reduces the final benefit when you retire. Self employed people pay class 2 and class 4 National Insurance contributions. Class 2 contributions only qualify you for the basic State Pension, and class 4 contributions do not qualify you for any pension at all. They are simply an extra tax on the self employed. Anyone who has tried to live on the basic State Pension will tell you that it is not enough.

The importance of pension planning

When you are in business, your energies are directed towards making a success of the business – and rightly so. You are in business because you believe you have a good service or product, and you believe that you have the ability to deliver that product or service to the people who need it, thereby making yourself a living.

But you should be focusing at least some of your energies on providing for yourself after you retire.

• Perhaps you want to pass the business on to your family.
• Perhaps your aspiration is to retire early – maybe in your fifties, or even in your forties.
• Perhaps you really don’t see yourself as stopping and doing nothing, so you want to continue some kind of gainful activity even into your later years.
• Perhaps you don’t see yourself as retiring at all, and you want to carry on until you drop.

Whatever your aspirations, you must do something to provide the means to be able to enjoy those years in some comfort -or at least without having to bear unnecessary financial worries. And even if you imagine yourself in that category of carrying on until you drop – think of your dependants. Spare them the worry and despair of having to cope in difficult financial circumstances.

The message is quite clear – you must think about, and do something about providing for your retirement. More than that – you need to do it now! Whatever stage you are at in your career, it is never too early to start saving for your retirement.

The urgency of pension planning

The pensions crisis

The State Pension system in this country is not on a ‘funded’ basis. That means that when you start paying National Insurance contributions, they do not go into a fund to provide for a pension for your retirement. They go on providing pensions for people who are presently retired. This causes its own problems in an ageing population.

As our life expectancy increases, the average age of the population increases – this is known as an ageing population. So, the more people over retirement age, the greater the amount of pensions which have to be provided by people who are still working and paying National Insurance.

Here are the actual figures – currently, there are 27 pensioners for every 100 people of working age. By 2050, there will be 48 pensioners for every 100 people of working age.

In response to this growing problem, the government is encouraging people by tax incentives to make more provision for their own pensions, either privately or through employers’ schemes. There are moves to extend the retirement age, or at least to encourage people to put off drawing their State Pension for longer.

The danger of putting it off

Consider the case of twin brothers. They start work on the same day, when they are 20 years old. The wise brother starts saving immediately £100 per month into his retirement fund. Assuming a steady interest rate of 5% on his savings, by the time he is 65, he will have a retirement fund of nearly £203,500.

The foolish brother puts off saving for his retirement. If he puts il off for five years, his retirement fund will be only just over £153,200 by the time he is 65. If he puts it off for 10 years, his retirement fund by the age of 65 will only be just over £114,000.

Put it another way – if the foolish brother puts it off for five years, he will have to save £132.80 per month to get the same retirement fund as his brother. If he puts it off 10 years, he will have to save £178.37 per month to get the same fund. And the figures get progressively worse for each extra year he puts off saving for his retirement.

Providing for yourself

The clear message is that you cannot rely on the State Pension in the same way as people have done in the past. In the future, you will have to rely more on your own private provision for your pensions. How do you do this?

The way to provide for a pension – particularly from your business – is what the rest of this book is dedicated to.

Quantifying the need

Before thinking about how to provide for your pension, the first step is to try to calculate how much you aspire to get as a pension in your retirement. Try following these steps, which are quite easy on a spreadsheet:

• 1.Enter your present income.
• 2.Enter the expected rate at which your income will increase until retirement.
• 3.Enter the number of years until retirement.
• 4.Enter the percentage of your final income which you expect to get as a pension.
• 5.Enter the expected rate of growth of your retirement fund.
• 6.Enter the expected annuity rate for a pension fund at your retirement date.
• 7.Use the ‘future value’ function on the spreadsheet to calculate your expected income at retirement date.
• 8.Multiply this by the percentage you have entered at step 4.
• 9.Divide this by the expected annuity rate you have entered at step 6, to arrive at the pension fund you will need to achieve your expected pension.
• 10.Use the ‘payment’ function on the spreadsheet to calculate the monthly payments you will need to save to achieve the pension fund, using the growth rate you have entered at step 5.

Simplification in 2006

In April 2006, the government has announced that there will be a ‘simplification’ of pensions, and in particular, the taxation treatment of pension savings.

At present, there are eight tax regimes for pension savings schemes which attract tax relief. These will be replaced by a single regime. Details of this simplification are given in Appendix 1.