Wednesday, April 09, 2008

Some hard, basic truths about the P word

(The following comes from an ezine that I subscribe to. Although the article is aimed at UK readers, I'd imagine that the equation is just as true anywhere. Prices are in UK sterling, just double the figures to gain a US dollar equivalent.)

I don’t want to worry you, but I’m going to anyway.

It will only take just one word.

Pension.’

There, that put your anxiety level up a notch, didn’t it?

But please don’t stop reading, even though your every
instinct will be screaming ‘Run! Run for your life...’

Check this out: 13 million people in the UK are saving
NOTHING AT ALL towards their retirement. When I read that
this morning, I almost choked on my cornflakes.

How much are YOU saving?

In fact, let me ask you another question: “How much do you
NEED to save?”

To answer that, you need to know 2 things:

1. How much money you want when you retire?

2. How fast inflation and savings will grow?

And I’m going to make the answers easy for you.

It is widely agreed that when you retire, you need between
half and two thirds of your current salary (or whatever
salary you would be reasonably comfortable on right now).

Considering today’s money, if you’re on £25k (which, by the
way, is the average salary in the UK) you need a pension of
between £12.5k and £16.5k. You can manage on this amount
because you will not pay tax or NI on it, and your living
costs are likely to be lower when you are older.

Fine. Next piece of the puzzle is this: “What’s that in
FUTURE money then?”

Easy answer: Forget about that. As a first approximation,
savings and inflation will grow at about the same rate, so
you only need to think in today’s money and not worry what a
loaf of bread will cost in 30 years time, or what £1000
saving will be worth in 30 years.

A quick and dirty (but good enough) calculation tells us that
if it costs you £20 a day to feed yourself now, it may cost
£80 a day in 30 years from now, but if you save £20 now, it
will be worth £80 in 30 years and so you’ve lost nothing.

Final question (and you’re not going to like this)

Honestly... you’re REALLY not going to like this...

“How much do I need to save, then?”

Well, it depends how old you are but if you want two thirds
of final pay you need to save approximately:

If you start at 25, you need to save: 18%
at 35 = 26%
at 45 = 40%
at 55 = 77%

I’m hoping that’s the biggest wake-up call you’ve had all
year!

Looking at those figures, you may feel shocked, defeated,
hopeless. I don’t know.

One thing I DO know is that the sums are correct.

Don’t forget of course that if you’re able to get into a
decent company scheme, your employer will contribute some of
this on your behalf, so it’s not as bleak as it seems.

But, if you’re WAY below this level of saving then you are
setting yourself up for a miserable, impoverished old age.
The state will give you about £100 a week and pay your
council tax (both means tested!).

Could you live on that? I doubt it.

Maybe you think your house is your pension?

Firstly, let’s get something out of the way. This IS true if
you have a property currently worth above a million, and/or
you own a string of flats or other houses totalling this
amount or more. If this is you, then congratulations. Barring
major permanent property price collapse (most unlikely)
you’re sorted.

But for everyone else, it’s time for some basic sums.

And it’s time to get real...

The average house in the UK is worth about £180,000.00,
depending who you believe. Let’s be generous and say £200k.

But you have to live somewhere. Could you really live in a
place half the size? Maybe, but that’s a big downsize. And as
you know, a place half the size would not cost half the price
– it doesn’t work like that!

Small places are more expensive, relatively. £200k would buy
you a 3-bed house in many areas. 100k would buy you a bedsit,
not a 2-bed flat. So you need £130k of your £200k to get
yourself a new place.

Leaving just £70k for your pension...

Oh, and don’t forget agent’s fees, HIPS, stamp duty and
moving costs. That’s another 10k bite out of your ‘pension’.
So you’re left with only £60k.

And of course I’m assuming that when you retire you will have
100% equity in your house – mortgage fully paid off. That’s
going to take some doing as most people are maxed-out on
their mortgages having borrowed extra for really essential
stuff like designer kitchens, sofas, flat screen TVs and the
such.

60k will buy you a flat rate pension of around £79 a week if
you retire at 65. These figures are all in today’s money of
course.

Maybe you’re reading this sitting in a house worth £500k and
are feeling rather smug?

Let’s see...

Well, you’re not going to live in a bedsit when you retire,
particularly after enjoying a 4-5 bed home in a decent area
for many years.

And anyway, 65 is quite young these days and you may want to
live in your nice house for at least a further ten years
before downsizing.

In any case I reckon you’re going to need £300k for a decent,
smaller place in a rougher area. That leaves you £200k which
will buy you a pension of about £250 a week. Okay, you could
probably live on that, but my point is you may have thought
you would be FAR better off than that.

Again I’m also assuming you will have paid off your mortgage.
And, by the way, I’m assuming you are happy to disinherit
your children (if you have any or are thinking about having
some)! They’ll be getting at least half less of the money.

Hey, you may be, but please at least think about that factor.
You can’t spend most of your equity on a pension AND leave it
to the kids.

So my strong advice to you today is to forget about your
house being a pension. It is no such thing... unless you are
a property tycoon with a string of properties – then you’re
okay.

And please don’t forget we’ve seen an unprecedented boom in
house prices over recent years. Many people who know about
such things (or think they know!) say this is unsustainable
and that prices will flatten off or fall. This means that the
value of your ‘house pension’ will also fall in real terms.

Can’t happen? UK property prices have fallen each month for
the last five months.

Something to think about!

2 comments:

Mercurior said...

i have an awful feeling of deja vu.

the sense in the uk, the atmosphere, feels like 92 all over again.. and we all remember what what was like.

KARMA said...

1928 all over again