Suggested ways to save for a comfortable retirement in the UK given the lifetime allowance limits on pensions?

Question

I've heard the rumor that this March's UK Budget will lower the Lifetime Allowance (LTA) from £1M to £800k or even less. They might index this for inflation. That seems to me to be a pretty low figure if I'm to have a comfortable retirement off of it. Especially given my retirement age of 65 is approximately 30 years away, so it would have to account for 30 years of inflation plus last me longer due to an expected increased life expectancy.

Apparently the broad rule of thumb is that I can expect to get £550-£600 a year for every £10k in my pension pot. That means an LTA of £750k would only pay me £41,250-£45,000 per year in income before taxes. I assume that would be in the low rate tax band still by then, so I'd net £33k-£36k / year, or around £3k / month. That would barely pay rent on my current flat in London, and it's not even inflation adjusted!

So what other options do I have for saving for retirement besides socking money away in a pension? Should I get a public services job to have a defined benefit pension? Are ISAs expected to make up the difference? Or are there other options?

Answer 1

Your main choices are ISAs and property. You can put over £15,000 per year into an ISA, which means over £450,000 by the time you retire, not allowing for growth in your ISA investments. But if you're paying rent, and worried about being able to pay rent when you retire, the obvious choice is to buy a flat now on a thirty-year mortgage so that you can stop paying rent and the mortgage will be paid off by the time you retire.

Answer 2

Obviously you should aim to max out your pension, though this is a bit of a judgement call, as future growth could take it over the limit even once you stop making contributions.

A public service job with a defined benefit pension won't make much difference, as they are also assessed against the lifetime limit at a multiplier of 20x the annual pension - so a similar rate to what you're looking at anyway (£500/year corresponds to a £10K notional pot). On the other hand public service pensions are protected against inflation - if you wanted an equivalent defined contribution pension, annuity rates are actually quite a bit lower than that - more like £350-£400 per £10K.

Apart from a pension, I'd suggest making sure you own your own property by the time you retire. The rent you save by doing that is effectively tax-free, though you have to pay for the mortgage out of taxed income. So it's equivalent to saving in an ISA, but with the added benefit that you are effectively "hedged" against rental changes.

After that ISAs are the next logical investment vehicle, though be aware that cash ISAs don't pay very good returns at the moment.

Answer 3

You have a large number of possible choices to make, and a lot of it does depend upon what interests you when you are older.

The first thing to note is the difference between ISAs and pension-contribution schemes tax wise, which is of course the taxation point.

When you contribute to your pensions scheme, it is done before taxation, which is why when you draw from your pension scheme you have to pay income tax. Conversely, your ISA is something you contribute to after you have already paid income tax - so besides the 10% tax on dividends if you hold any assets which may them, it is tax free when you draw on it regardless of how much you have accrued over the years.

Now, when it comes to the question "what is the best way to save", the answer is almost certainly going to be filling your pension to the point where you're going to retire just on the edge of the limit, and then putting the rest into ISAs. This way you will not be paying the higher rates of tax associated with breaking the lifetime limit, but also get maximum contributions into your various schemes.

There is an exception to this of course, which is the return on investment. If you do not have access to a SIPP (Self Invested Personal Pension), you may be able to receive a far higher return on investment when using a Stocks & Shares ISA, in which case the fact that you have to pay taxes prior to funding it may not make a significant difference.

The other issue you have, as others have mentioned is rent.

While now you may be enjoying London, it is in my opinion quite likely that will change when you get older, London has a very high-cost of living, even compared to the home counties, and many of its benefits are not relevant to someone who is retired.

When you retire, it is quite possible that you will see it fit to take a large sum out of your various savings, and purchase a house, which means that regardless of how much you are drawing out you will be able to have somewhere to live. Renting is fine when you are working, but when you have a certain amount of (admittedly growing) funds that have to last you indefinitely, who knows if it will last you.