Five years from retirement? Here’s what you need to consider

The fear of having insufficient savings to retire on our own terms is the motivational jolt many of us need. Most of us need to save and invest diligently to achieve the holy grail of financial freedom.

Making good decisions and avoiding bad ones throughout your working years can have material consequences on the lifestyle you secure in later life. And these choices carry particular weight when you hit the home straight to retirement. Time is running out to whip your finances into the desired shape – a sharper focus is needed.

• Learn more: SIPP Drawdown | SIPP Withdrawal Rules | Open a SIPP 

So, what are the things you need to think about when you’re on course to pack up work in five years’ time? Here are six considerations.

1) Firm up your retirement plans

At this point you should have a solid idea about how you’d like to live out your golden years, but now’s the time to properly drill into your goals.

Key things to get a firm grip of include: the age that you plan to stop working, whether you prefer to stop completely or continue earning in some capacity and phase into retirement, what a comfortable retirement means to you and how much income you’ll need achieve to this.

• Six things to know about volatile markets and your pension
• Sign up to our free newsletter for investment ideas, latest news and award-winning analysis

To establish whether things are on track, you need to be clear about your target income, which you can then translate into a target pot size. Multiplying the income required by 20 is one rule of thumb to work this out. So, if you need £20,000 a year in retirement (excluding state pension – more on that further down), you’ll need to save around £400,000.

2) Check your savings are on track

Optimistically waltzing towards a post-work life hoping that whatever you’ve saved will do the job is a risky approach. When you’re half a decade from retirement, it’s important to know where you stand.

That doesn’t mean you should reach for the panic button – you still have time on your side to make a difference and get your savings where they need to be. Using a pension calculator, such as this one from ii, can help you gauge where you stand and uncover the action needed to plug any gaps.

While pensions will form the bulk of most people’s retirement portfolio, make sure include other assets, such as individual savings accounts (ISA), cash savings, general investment accounts (GIA), investment bonds, second homes, and businesses assets, if applicable.

• Don’t forget the state pension

Some people worry that the state pension will have disappeared by the time they retire. And although we can’t predict the future, there’s nothing to suggest it will be kiboshed, so factor it into your calculation. You can claim it at age 66 (rising to 67 in 2028 and 68 in 2046) and the full amount is currently just under £12,000 – a tidy and valuable inflation-linked sum to cover your essential spend.

If you plan to retire before you’re eligible to claim the state pension, make sure you have sufficient savings to cover your outgoings until it kicks in.

3) Consider beefing up your savings

Five years from retirement is a great time to supercharge your pension savings, so with any surplus income or savings consider boosting your monthly contribution and/or pumping in lump sums.

Most people can pay the lower of £60,000 or 100% of earnings into a pension every year and get tax relief at their marginal rate - either 20%, 40% or 45%. Your money grows tax-free, too. Note that if you earn more than £260,000 or have already started to draw from your pensions, you might be restricted to £10,000 a year.

But there might be scope to pay in more. Carry-forward rules enable you to tap into unused annual pension allowances from the past three years, although the 100% of earnings cap still applies. Sacrificing work bonuses into your pension is particularly tax efficient, as you can save both income tax and national insurance (NI).

Also be mindful that pensions aren’t the only tool to help you save for and fund later life. ISAs can prove a savvy sidekick. You may not get tax relief on what goes in, but there’s no tax on growth or on anything you take out. And with an annual allowance of £20,000, there’s lots of room to shovel money away between now and retirement.

4) Revisit your asset allocations?

One of the big considerations in your final saving years is whether to reduce investment risk. Retirement usually prompts a change in objectives – you stop paying money into your pension (in most cases) and start taking money out.

But whether you should derisk your pension investments – which usually involves gradually switching from riskier assets such as shares into safer ones like bonds and cash – is not a cut and dried decision.

Since the 2015 pension freedoms, people have tended to keep their money invested throughout retirement and draw income flexibly, using something like a self-invested personal pension (SIPP).

• A decade of pension freedoms: what you’ve done with your money
•  Is it possible to give away my pension savings to avoid IHT?

If that’s your preferred strategy, then heavy derisking might not be best. To generate retirement income that keeps pace with the rising cost of living, your savings need to be geared for growth. Taking less risk means restricting potential returns. This can harm how long your savings last, especially if you live a long and healthy life.

However, staunchly keeping your pension in the stock market when you plan to buy an annuity - a guaranteed income for life or a set period - immediately at retirement, should typically be avoided. If markets slump, dropping, say, 25% before your retirement date, the annuity income offered will drop proportionately. You’d be forced to either retire on a lower amount or wait until things recover. The latter might not be an option.

To summarise, there’s no universal approach when it comes to shifting asset allocations - specifically whether you should take a more defensive approach - as you near later life. Just make sure your strategy is well thought out and chimes with your income goals.

• Check any current or previous workplace pensions

One banana skin to swerve: some company pensions have lifestyle strategies baked in, meaning you automatically switch to safer assets over the final five to 10 years.

Another thing to watch out for. Some schemes move your pension money into cash once you hit your specified retirement age, which might have changed since you started the pension. This could harm future growth if your retirement date has been pushed back several years.

5) Keep an eye on debts

In an ideal world, you’ll reach later life with no debt, freeing up your wealth to spend on things you enjoy. But the reality isn’t always that simple. Due to soaring house prices over the past few decades and recent higher borrowing costs, people are either buying homes later than before and/or taking out longer mortgage terms that spill into retirement.

As such, a key decision for some savers is whether to use any surplus cash or income to clear debt early or beef up pension savings. The most suitable approach depends on things such as the tax rate you pay (pensions are particularly attractive to 40% and 45% taxpayers), your mortgage rate, early repayment charges, and the size of your retirement savings.

Either way, your first port of call should be to consider reducing any high-interest loans, such as credit and store cards. The interest charged on such debt could be 25% or higher, causing balances to spiral if not kept in check.

6) Think twice before accessing pensions early

Under current rules, most pensions can be accessed at age 55, rising to 57 in 2028.

While it might be tempting to raid your pot before you retire, take a step back before doing so. Any money you draw from your pension early will give you less to live on in the future.

• Five secrets to saving for retirement as a couple
• Check whether you could pay less in pension charges by using our SIPP comparison calculator

There are, however, sound reasons to access your savings, such as to clear expensive loans, as mentioned above. You can draw up to 25% (capped at £268,275) of your total pension funds tax free, which might be a tempting option if you find yourself needing some liquid cash.

But be aware that if you make a taxable and flexible pension withdrawal, the maximum amount you can stick into a pension every year and get tax relief falls to £10,000, and you can no longer use carry forward relief – restricting the options to boost your savings as retirement draws closer.