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Is your pension forecast too optimistic? Why you need to look beyond the headline sum

When you review your pension, it’s likely to be the forecast that you focus on. This figure is designed to give you an idea of how much your pension will be worth when you reach retirement age. However, the sum is based on certain calculations, and a report suggests some results could be too optimistic, potentially leaving you with less money in retirement than you expect.

What is a pension forecast?

Most workers are now paying into a defined contribution (DC) pension. This is when you and, in most cases, your employer make contributions that are then invested. Once you reach retirement age, you’re able to access this lump sum to create an income. As a result, the amount you have for retirement depends on contributions and investment returns.

You should receive an annual statement from your pension provider, which will include a pension forecast. However, this sum is not guaranteed and is based on certain assumptions. These assumptions could include investment returns, your contributions rising due to pay increases, or the rate of inflation. These assumptions differ between pension providers.

The assumptions made can have a huge impact on the forecast that’s given.

Pension investment returns have fallen, and it could affect the accuracy of your forecast

A new report from Interactive Investor suggests the assumptions made about investment returns can vary widely and some providers are being too optimistic, especially as returns have fallen in recent years.

The Financial Conduct Authority (FCA) publishes pension investment performance figures every four to five years to ensure projections are realistic.

The findings show return assumptions are not consistent, ranging from 4% to 7% for shares. In fact, data shows the average real rate of returns could be significantly below this range. In 2007, the average rate of return on pension statements was 4.2%, and in 2017 had fallen to 2.4%.

Lower than expected returns when saving for a pension could have a huge impact on how much you have. An example in the report highlights this:

A worker automatically enrolled into a pension at age 22 and on a typical wage for someone in their twenties, would have a pension forecast of £131,000 assuming an investment return rate of 4.2%. However, using the most recent return assumptions (from 2017) of 2.4%, the forecast would fall to £85,000.

Basing your retirement plans solely on a pension forecast could mean you fall short and need to make adjustments.

How does your pension forecast relate to your retirement plans?

As well as assumptions affecting pension forecasts, it’s also important to consider what a pension forecast means for your retirement lifestyle. How much do you need to save to secure the retirement you want?

There are lots of “rules”, such as needing two-thirds of your working income to maintain your lifestyle in retirement. But this doesn’t consider your circumstances or what you want your retirement lifestyle to look like.

To understand if your expected pension lump sum is enough for you, you first need to think about the retirement you want. If you will still have debt when you enter retirement, such as a mortgage, the amount you need once giving up work is likely to be higher than the rules suggest. On the other hand, you may plan to spend more in retirement if you want to travel or upgrade your home.

You’ll also need to think about other factors when assessing your pension lump sum, such as:

  • How long will your pension need to last?
  • Will your income needs change throughout retirement?
  • Do you need to plan for potential care costs?

So, it’s not just how the pension forecast is calculated that you need to work out if you’re saving enough, but what you want your retirement to look like.

How financial planning can help you understand your pension savings

Financial planning can help you understand both how your pension contributions may increase over your working life and the lifestyle you can then look forward to. By taking a tailored approach, you can make sure your pension is on track to achieve the retirement you want.

It also provides you with an opportunity to consider potential risks to your plans and take steps to minimise them. For instance, what would happen if your pension investments underperformed? And could you afford to retire early if you become ill?

Financial planning can help you have confidence in the steps you’re taking to prepare for retirement. If you’d like to discuss your pension, please contact us.

Please note: This blog is for general information only and does not constitute advice. The information is aimed at retail clients only.

A pension is a long-term investment. The fund value may fluctuate and can go down, which would have an impact on the level of pension benefits available.

Your pension income could also be affected by the interest rates at the time you take your benefits. The tax implications of pension withdrawals will be based on your individual circumstances, tax legislation and regulation, which are subject to change in the future.