The State Pension is the cornerstone of retirement, but it needs further support and for me that means investing in a Stocks and Shares ISA.
The new State Pension, paid to everyone who retired from April 6 2016, currently pays £10,600.20 a year at most. Those with fewer than 35 years of National Insurance contributions get less.
Even the full sum probably isn’t enough to live on. A single person needs £12,800 a year after tax to achieve a ‘minimum’ living standard in retirement, according to the Pensions and Lifetime Savings Association. This rises to £23,300 a year for a ‘moderate’ lifestyle, and £37,300 a year to be ‘comfortable’.
Retirement eats money
If I could invest enough in a Stocks and Shares ISA to double what I get from my State Pension, I’d be well on the way to a moderate retirement (I’ve got some legacy workplace and personal pensions too).
To generate £10,600 a year from shares, I’d need a portfolio worth £265,000 in today’s money. I’m basing that on the so-called 4% rule, a benchmark that says if an investor draws out 4% of their portfolio each year, the pot will never run dry.
If my portfolio yielded 7% and I took all my dividends as income, I would only need to save £151,430, but there’s a risk my capital will shrink. So let’s be ambitious here, and aim for £265,000. How much would I need to invest each month for that?
It’s a question of time. If 30 years from my target retirement age and investing £175 a month, I could beat my target with £285,848.
If 20 years away and investing £410 a month I’d have £265,055. With 10 years to go, I’d have to invest £1,333 monthly to reach £265,155.
These figures all assume I increase my contributions by 3% every year, and generate the average long-term return on the FTSE 100, which is 6.89% a year. In reality, I’d need to invest more, as inflation would erode the value of my £265,000 pot and the income it generates.
I’d pop dividend shares in my ISA
While the State Pension looks pitifully low, these figures show that replicating it is hard. The joy of investing through a Stocks and Shares ISA is that all income is free of tax, even if it pushes a saver well over the personal allowance.
Please note that tax treatment depends on the individual circumstances of each client and may be subject to change in future. The content in this article is provided for information purposes only. It is not intended to be, neither does it constitute, any form of tax advice. Readers are responsible for carrying out their own due diligence and for obtaining professional advice before making any investment decisions.
In practice, I’d try to save much more than £265,000 to enjoy a comfortable retirement rather than a moderate one. I’d also try to generate maximum dividend income, by investing in high-yielding FTSE 100 shares.
Loads of top UK different stocks yield 7% or more right now, with many trading at cheap valuations. I’ve recently bought Rio Tinto, which yields 8.53%; Legal & General Group, which yields 8.44%; and fund manager M&G, which yields 10.1%. There are plenty more top dividend shares on the FTSE 100 today.
Investing is risky, of course. Dividends can be cut, share prices may crash. In rare cases, FTSE 100 businesses can go bust.
Yet I think they remain the best way of supplementing my pension with dividend income and capital growth, tax-free inside a Stocks and Shares ISA.