Ian asks: “I’m 25 and I’ve recently started working with a new employer. I’ve been given certain options in terms of salary sacrifice. Which would you recommend that I go for?”
Q&A 67 – Pension Advice – Shownotes
I’m 25 and I’ve recently started working with a new employer and I’m able to define my pension contributions and how the company invests that money.
I’ve been given the following options in terms of salary sacrifice:
Member Contributions 3% 4% 5% 6% 7% 8% 9% Employer Contributions 3% 3.5% 4% 4.5% 5% 5.5% 6% Total Contributions 6% 7.5% 9% 10.5% 12% 13.5% 15%
I’m thinking of going with a contribution of 6% – giving a total contribution of 10.5%. With my current salary this works out to be £2,362.50 per year. Would this be a reasonable figure?
The company where I work generally review salaries once a year, so I would expect this to increase as time passes; but it gives me a good reference point. Once I hit 65 I should have £93,909 saved up. Adjusting for future inflation, would this be alright?
Any suggestions as to what to do here? This is the first time I’ve come across something like this, and I haven’t a clue what to do. As somebody who knows a lot about personal finance, what would you do?
Ian, thanks for your question and well done for thinking about your pension so early in your career and at such an early stage in your financial journey. Your older self is going to be mighty pleased with this 25 year old self for thinking about this now.
Making A Detailed Budget
The first thing you need to do Ian is make a detailed budget of all of your income and expenditure. Our overall advice is to contribute as much to your pension as you can, up to the maximum of where the employer match ends.
However, if this doesn’t leave you with enough cash each month to live and eat, then this obviously wouldn’t be the optimal decision. So, first of all, get your finances under control to make sure that you can realistically contribute 9% of your salary.
Will You Have Enough Cash To Live?
Working backwards from your question, you say that 10.5% of your salary is £2,362.50 and hence we can assume your annual salary is £22,500.
If you contributed 9% of your salary to your pension now, you’ll be contributing £2,025, and your employer would match 6%, which would be another £1,350. So, you are effectively getting a payrise of £1,350 by maximising your employer match. Not bad.
After taxes and student loan deduction (I’m assuming as you mentioned university that you have student loans to repay), this would then leave you with £16,866 net pay a year, or £1,405 per month.
Is this enough to cover your expenses each month and give you a little on the side for emergencies? For most people, this would be a little tight, but you’ll only be able to know this if you make your detailed budget, and it will obviously depend on your large expenditure (are you renting or do you live with parents, etc.)
Will You Have Enough In Retirement?
You then ask whether this will be enough for when you retire. The short answer is yes.
Let’s say that you contribute 9% of your salary and your employer matches 6% from the age of 25 to 65. We’ll also say that you never receive a pay rise above inflation, and that you invest that money in a pension which earns a net 5% overall return above inflation. All of these assumptions are very conservative for a university graduate who is investing their money wisely in their pension.
At the age of 65, in today’s money, your pension account would be worth £428,084. If you then assume a 5% drawdown with a 5% annual return (you never actually reduce that pension pot), that would then pay you £21,404 per year (or equal to your annual salary whilst you were working).
Let’s imagine that you earn a salary increase of 2% above inflation over your career (this should again be realistic and probably even prudent), then those figures pop up to £570,774, giving an annual salary in retirement of £28,538.
So, Ian, in conclusion my advice would fall into two steps:
- Make a detailed budget of your income and expenses to see how much you need every month to live on.
- Contribute as much as you can to your pension up to the maximum of what you can afford from step 1 and/or the maximum that your employer will match (9% contribution by you).
Even if for the time being you can only afford the 6% with the 4.5% match, it will be enough for your retired self to sincerely thank your 25 year old self for making that decision!
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