How much to save

According to Adrian Boulding, pensions strategy director at Legal & General, a good rule of thumb is to halve the age at which you start to make pension contributions, and pay that percentage of your income into a fund until you retire. This should give you a pension of around two-thirds of your salary. So if you are aged 30, you need to pay in 15% of your salary.

The worst thing you can do is delay starting to make contributions, because failure to take advantage of the early years of growth, coupled with the effects of inflation, conspire together to cut into potential returns. For instance, if a 30-year-old woman earning £40,000 pays 5% of her salary into a pension plan and her employer matches her contributions, making a total of 10%, she would end up with an annual pension income at 65 of around £13,500, assuming salary growth in line with inflation. If she delays her contributions by just five years, her annual pension would reduce to just £10,280, even though she had still managed to save for 30 years of her working life.

Delay is not the only danger. Inflation on its own will have a devastating effect – 30 years of today’s rate of around 2.5% would reduce the spending power of your pension pot by half. You might also be affected by annuity rates. This is the price you pay for a regular income for life in exchange for handing over your pension savings. Just about everyone who saves for themselves in a pension plan, either with or without employer contributions (rather than having a pension provided by their employer and linked to their final salary), will eventually have to buy an annuity. Because of increased life expectancy and poor returns on gilts – Government stock largely used to back annuities - rates have virtually halved over the last 10 years.

For every £100 you hand over at the outset, the annuity provider will pay out a percentage – typically around £5 or £6 a year. The amount you get will depend on your age when you take out the annuity, your sex and medical history and the type of annuity you buy – perhaps whether it is a flat rate “level income” annuity, or one that rises with inflation, or for one person or joint life for a couple.

This may seem extremely expensive, but the annuity is guaranteed to pay out for life. So your income will never run out, as it might if you were managing your money by drawing down your savings.

Can you afford a pension?

It is better to ask can you not afford one.

Take the latte test

Figures from insurer Aegon show that a pension contribution of just £2.40 per day, the cost of a fancy cup of coffee, could allow a 35-year-old earning £23,000 a year to reach a target pension, ignoring state pensions, of half their final salary at age 65. Drinking the coffee rather than making the contribution would mean the person would have to work for another two years, to the age of 67, to reach the same target.