Tom McPhail | Jun 2012

Stuck on an overcrowded train to work at 6am, with your neighbour’s umbrella dripping on your newspaper, do you ever think ‘I can’t wait to stop working?’ Do you ever daydream about lie-ins, long holidays and neglected hobbies?

But transforming that dream into reality doesn’t come cheap, so how could you afford it?

Once you have paid off your debts, like it or not, the answer is likely to depend on what shape your pension is in.

Seven tips to whip your pension into shape
1. Start a pension – the earlier the better
It sounds obvious, but the obvious is often overlooked. Indeed almost four in ten British adults don’t have a pension, including 1.4 million who are within a decade of retiring.

How much should you save?
It is generally assumed that to retire at 65 you’ll need about 2/3rds of your salary. Roughly speaking, to find the ‘magic number’ – how much you should put away every month – divide your age when you start saving by two and contribute this as a percentage of your earnings. For example, if you’re 30 you should aim to save 15% of earnings. To retire at 55 you’ll need to save more. The earlier you start, the less it should cost you to build a decent pension.

Want to find out your ‘magic number?’ This free interactive calculator can help you play around with some figures, including your retirement age, and reveal how much to put away to try and achieve your target.

2. Claim your share of the £32.9 billion the taxman gives pension savers
Did you know that when you put money in a personal pension the taxman chips in too?

Say you pay in £1,000. The taxman automatically adds another £250, so you end up with £1,250 in your pension.

If you pay 40% or 50% rate tax, you get an even better deal.

You can claim back extra money through your tax return. This means that £1,250 in your pension could cost you as little as £625.

Guide to Pension Tax Relief
Find out how pension tax relief works and how you could claim up to £100,000 back from the tax man.
Claim your Guide to Pension Tax Relief
Practically everyone under age 75 can benefit.

We usually only see the taxman’s money-grabbing hand. Tax relief on pensions is one of those rare occasions when his generous hand gets an outing. Why miss it?

The amount you get from the taxman depends on your circumstances and tax rules can change.

Do you want to see how much is up for grabs? You can work out how much tax relief you could get with this tax relief calculator.

Try now – free tax relief calculator

3. If they offer you a pension at work, take it!
Companies, especially the large ones, usually offer workplace pensions. In many cases, they can also pay money into your pension. The good news is that by 2016 all companies in the UK will have to offer a pension to their employees. If you opt out, you could be missing out on ‘free money’. But remember: your employer’s contributions are just a helping hand – you will need to add your own to retire early.

4. Check where your pension is invested
Do you ever check the value of your home – even if you have no intention of selling it? It’s perfectly natural; your home is one of your largest assets, just like your pension. Yet, do you check the value of your pension? Do you know where it’s invested? Alarmingly, nearly half of Britons have no idea.

Why is it important to know where your pension is invested?

Quite simply because you could miss out if you didn’t. All investments go up and down so you may end up with less than you invested. That said, not all investments are the same and the difference could have a significant impact on your pension.

To illustrate that, look at the graph below. The purple line shows the performance of one of the UK’s most successful managed funds, Invesco Perpetual High Income, which is an investment choice for some pensions.

The blue line shows the average performance of the funds pensions are likely to be invested in. When you look at the graph, please bear in mind great returns in the past do not mean the same will happen in the future.

What difference does a good fund make?

May 2007-08 May 2008-09 May 2009-10 May 2010-11 May 2010-12
Invesco Perpetual High Income Inc -6.4 -20.0 21.4 14.3 7.8
As the graph shows, all investments fall in value as well as rise, and please remember past performance is not a guide to future returns.

Source: Lipper Hindsight, 01/05/1992 to 01/05/2012. Calculation: The graph shows the performance of Invesco Perpetual High Income Fund (Income Units) and the ABI UK – Mixed Investment 40%-85% Shares (Pension).

Please note: some pensions restrict your investment choice. This Free guide to SIPPs tells you how you could entrust your money to some of the UK’s best fund managers.

5. Make small, regular increases – they could go a long way
Would you really miss £7.50 a month? That’s less than you’d pay for a take-away but it could go a really long way if in your pension.

Look at this example. John is 25 and contributes £150 net to his pension every month. If every year he increases that amount by just 5% (£7.50 a month for the first year), at age 65 he could find himself with an extra £137,693 in his pension, assuming John gets basic tax relief and the fund grows 5.5% a year after charges.

Never mind take-aways: this should pay for quite a few fine dining meals!

How much more could you get if you increased your contributions by just 5% every year?

Of course, these are just projections; the actual return could be less or more than this. The figures show the values in today’s terms, without considering inflation, which will reduce the spending power of money over time. Moreover, investments are not guaranteed: they can go down as well as up in value so you could end up with less than you invested and the tax relief mentioned depends on individual circumstances, reflects today’s tax rules and may change in the future.

If you are thinking of topping up your pension, please note: there are rules and restrictions to how much you can contribute, per year and over a lifetime. If you’re unsure, please ask your pension provider.

Want to know more? This free guide gives 10 practical tips to improve your pension

10 practical tips to improve your pension

6. Track down old pensions
Few people stay with the same employer for life – the average is 11 jobs in a lifetime. And even fewer people keep track of all the pension schemes they have joined during their career. Some estimate the total of unclaimed pension is in the scale of billions.

If you remember joining more than one pension but don’t have the details to hand, you can trace them free with the Pension Tracing Service.

7. Approaching retirement? Shop around for up to 40% more income
Even if you are already close to retirement, there’s one last thing you could do to squeeze more money out of your pension.

When you retire, you can usually take up to 25% of your pension as tax-free cash. After that, most people will take a taxable income from their pension. They usually do so by buying something called an ‘annuity’. An annuity provides a secure income for at least the rest of your life in return for your pension fund.

Annuity rates can vary significantly, depending on the provider you choose. What’s more, there are over 1,500 medical and lifestyle conditions that could help you increase your annuity income. You don’t have to be seriously ill to qualify, you just need to request an ‘enhanced annuity’ and as the chart below shows, you could get thousands of pounds more every year for the rest of your life.

Male aged 65 with a fund of £25,000. The annuity is single life and level, with a five year guarantee, paid monthly in arrears. Source: HL Annuity Supermarket and Just Retirement, 3 May 2012.

As a result, when you shop around for your annuity, you could get up to 40% more.