Why You Should Start Saving for Retirement NOW
Preparing for retirement is huge challenge. Deciding when to retire, whether to downsize and how to fill your time are all important considerations. But retirement also has the potential to be one of the most fulfilling times in life. You have the opportunity to spend your time as you wish: spending time with friends and family, pursuing hobbies you did not have time for before and travelling to new places. Making the most out of your retirement requires a good attitude and good planning. Planning your financial future will allow you to enjoy your retirement as much as possible.
Research on spending habits by the International Longevity Centre - UK state that:
- Retirees are saving £48.7bn per year.
- Rather than spending 'their kids' inheritance' on holidays and leisure, older people spend decreasing amounts on non-essentials.
- On average retirees think they have a 70% chance of leaving an inheritance of £50,000 or more.
How does retirement work?
In the UK, every employee is automatically enrolled in a pension scheme with added tax relief. The employee, and employer each contribute a share of the salary. At present minimum pension contributions are 3% of income. In April 2019, they will rise to 8%. You cannot touch your pension until you are 55.
In addition to the compulsory pension scheme, there are supplemental voluntary programs for adding to your retirement savings. Originally called TESSA (tax-exempt saving schemes), these supplemental retirement schemes are now called ISAs (individual savings accounts). These accounts can be used as tax-free savings accounts, and you can also use these accounts to invest.
Making a retirement fund
Experts suggest that people in the UK will save between 10 - 15% of their income for retirement. Since the pension minimum in the UK is much lower than this recommended amount, it is to your advantage to set aside more money toward your future.
It is easy to delay your retirement savings. Maybe you just started your career, or you just had a baby and cash is tight. But the best time to start your retirement savings is NOW! This is because of compound interest. Because of the way interest works, starting your savings earlier will make a big difference on your retirement fund later down the line.
Interest is the premium that the borrower pays on a loan. It is also what an investor obtains from an investment. Compound interest is when the interest earned over the time of investment goes back into the fund, therefore interest is earned on the earned interest. Getting too complicated? Let’s keep it simple!
The formula for compound interest is:
V = P (1 + r) (t)
- V is the value of the investment at the end of the investment period
- P is the principal, this is the amount initially deposited
- r is the interest rate over the time period
- t is the number of time periods
What is compound interest and why does it matter to my retirement?
There are other forms of the equation which show different factors, but this will make things simple. However, something for certain is that the principal needs time to grow.
Using the above equation, somebody, invests in an asset which earns 5% a year. That means that at the end of one year, a £100 investment earns £5. After 10 years, it earns £62.90, 20 years, £165.30, and after 50 years, £1046.70. We see how the earnings become exponentially bigger over time.
By creating a retirement account now rather than delaying, you will have more bang for you buck over time. This means taking action now, by adding a higher percentage of your salary into your pension scheme. In more simple terms, it is a practical demonstration of Confucius’ famous saying that a “man who moves a mountain begins by carrying away small stones.”.
What does this mean for most people? The only way that you will be able to unlock the full potential of compound interest is to invest in your future as early as possible.
Living in retirement
It is a harmful myth that you can keep your exact lifestyle into retirement. While some expenses may decrease (you may have payed off your mortgage), other expenses will increase. Museum outings and early-bird specials add up! Consider the ways in which you can downsize your expenses without reducing the quality of life. Here are some options to consider:
- Consider selling a car - Do you and your partner have two cars? In retirement, it may be possible to share one car instead. This will save you thousands of pounds a year, and decrease your environmental impact.
- DIY projects - During your working years, it may have been more cost-effective to hire someone to complete a project than to do it yourself but now you are rich in time! Consider building yourself that new desk, rather than hiring a construction team to do it. DIY projects will both save you money and give you a great activity to pursue with your ample free time.
- Downsize your home. When your home is full of children, it makes sense to have ample space. But in retirement, it is likely that many of these rooms sit empty most of the time. Not only are you paying the higher mortgage/rent prices for the home, you are also paying utilities to heat and power a home much larger than you need. Large homes also require a lot of maintenance and work! Consider a more modest house or flat to cut expenses and give yourself a smaller home to clean and care for.
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