Financial Planners (New), Pensions

This section carries on from “The Simple Example Plan” for Fred Bloggs in order to consider pension planning in more depth. The only difference is the addition of the personal pension shown below…

Fred started this pension with his job in 2010, and is contributing £100 per month while his employer is topping-up this to make a total of £1,500 per year, incrementing in line with inflation (i.e. contributions increase at 4% p.a.). This significantly reduces his pension shortfall (after inflation), as shown below. The effect of his private pension is the difference between the blue and red bars in the first three years, while the effect of his state pension is the amount by which the red bar (i.e. the shortfall) decreases from year four onwards.

This extra pension even leaves him with surplus retirement income after 2058, when his state pension is included, as shown by his Lifetime Cashflow below. The reason for this is that his “Required Pension” at today’s prices is £10,000, while his expenses are just £8,000. So after both have increased with inflation, he’s actually left with more than enough to meet his expenses, though maybe not quite enough to liven up his retirement years.

Having checked the projections, above, click the “Back” button and then on the Excel spreadsheet right-click the “Percentage of pension to use” and change this from 100% to 50%, as shown below.

As you can see from the resulting Lifetime Cashflow projection below, although this would result in a sizeable sum on his 65^th birthday, his reduced pension would thereafter never be enough to cover his expenses.

Now go back, close the planner (n.b. no need to save), and then “Revise” Fred’s factfind. Click the “Remove” button next to his personal pension, then add the salary related one shown below, which will pay 1/80^th of his final salary multiplied by his 44 years of employment.

This results in a very uninteresting Pension Shortfall because there isn’t any, as can also be seen from his revised Lifetime Cashflow Projection, below, where clearly he now has enough pension income to more than cover his expenses.

You can use the “Yearly Breakdown” button to analyse how this comes about, as shown below for the first year of his salary related pension payment in 2055. His final salary in 2054 = £112,330.30, which when divided by 80 and then multiplied by the 44 years of his employment = £61,781.67. After 1 year’s inflation at 4% this results in his first gross pension payment of £64,252.93 in 2055, that’s reduced to £62,567.98 after tax. Given that his expenditure on food and clothing is just £44,932.12 (i.e. £8,000 p.a. after 45 years of inflation at 4%) he’s left with a healthy surplus.

Now close and return to the factfind again, then try exactly the same figures for a salary related lump sum, as shown below…

Because he’s getting a lump sum instead of an income this causes him to have the original pension shortfall, shown below, where the first three years are not covered by his state pension.

More interestingly, when you look at his Lifetime Cashflow you’ll see it’s very different from the salary related pension. The salary related lump sum is enough to cover his first year without a state pension in 2055, but that’s all. What he needs is to have this sum repeated every year, like it was for the salary related pension.