Building your own retirement is important to avoid experiencing an income gap later when you reach retirement age. The rule of thumb is that you should accrue about 70% of your average gross earnings over your lifetime in retirement. But what turns out? Most people build up only 40%. That means many people have a huge drop in income. And we want to avoid that! So to the task. But how do you do that, build your own retirement? Everything you need to know about building your own retirement can be found here!
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Why do you build up a pension?
In the Netherlands, we have a time when we feel that people have become too old to actively participate in the labor market. They may then stop working and retire. But because they then no longer participate in the labor market, they receive no income. The income is then replaced by another periodic benefit and we call it the pension.
Is pension the same as AOW?
The Dutch pension system has 3 pillars:
- AOW pension. This is our social system, and we all get AOW.
- Collective Retirement. This is the pension you accrue when you are employed.
- Supplementary pension. Here’s what you can do yourself that will help you close your retirement gap.
Pillar 1 is the state pension benefit. AOW stands for General Old Age Security Act. This is an amount that everyone receives in the Netherlands when you reach your AOW age.
The amount of your AOW does not depend on your previous income or the amount of the rest of your pension. But of your marital status. Single people receive a higher state pension than someone living together or married.
In addition, you often build up a pension through an employer during your working life (note, not always. At 1 in 10 employers, no pension is accrued). You will then receive this pension amount when you reach your state pension age. This is pillar 2. And finally, sometimes you build your own pension. You do that in pillar 3.
How do you build retirement in salaried employment?
Accruing a pension through your employer comes out of your gross pay, which is often supplemented by an amount from the employer. The employer pays a fixed percentage per year or chooses to supplement a fixed amount.
In most cases, an average pay plan is used. This means that when you retire, you will receive an average benefit based on the salary you received in your working life.
Generally, your pension that you accrue through your employer is lower than your last-earned salary, but it is thus supplemented by AOW. Yet many people still experience a decline in income when they retire.
Women even more than men, how come?
Read this article: women accrue 40% less pension than men.
How do you build retirement as an entrepreneur?
Whether you are self-employed or own a limited liability company: if you are not employed, then you must build up your own pension. In the Netherlands, 25% of self-employed people do not build up a pension. The reasons are often the cost or that one has not yet figured out how it works.
Also read: building a pension as a self-employed person
The government thinks it is important for entrepreneurs to build up a pension so that after their working life there is no shortfall, the state pension does not completely cover this after all. Building your own retirement can be done in several ways and there are roughly two flavors; saving and/or investing. In this article, we will discuss the two most common.
Also read: entrepreneurs and retirement the hard numbers
How do you build your own pension?
Not only business owners need to think about their pension accrual. A pension gap can also occur if you are employed. Indeed, in very many cases, people build up less pension than they need. This is called a pension gap or pension shortfall.
What is a pension gap?
So the pension gap is the shortfall in retirement; you have accumulated less than you need. This soon arises, for example, if you change jobs and end up with an employer that does not have a pension accrual plan. Or if you don’t have an employer for a while. Or if you go into business and do not accrue a pension or do so only after some time. But even if you accrue continuous pension through an employer, this pension gap can occur. For example, if you have a career average salary plan, your average salary is often a lot lower than your last-earned salary.
So building your own retirement is important for both business owners and salaried employees. How to build your own retirement?
Read the 7 steps to start building a good retirement now.
Saving for your retirement
A well-known form of pension accrual is bank savings. The name says it all, it’s a form of saving and you can use this to build retirement. The difference with a regular savings account is that your money is fixed until you reach retirement age. And, very importantly, you get tax benefits on this savings account.
In the Netherlands, independent pension accrual is not taxed. Indeed, the taxman rewards building up a pension. This means that, under certain conditions, you can deduct from your taxes the amount you put in for retirement. How much this is depends on the income tax bracket your income falls into. In addition, the accumulated assets are not included in Box 3, so you do not pay wealth tax on this amount. Read more about the tax benefits here.
The payment of your saved amount occurs over a period of time, so you will not receive the entire amount in your account at once.
The benefits of bank savings are:
- A guaranteed pension amount, even the interest rate is fixed.
The disadvantages of bank savings are:
- Your money is fixed until retirement age. You can “buy out” this earlier, but there is often a penalty fee attached.
- Bank savings generally provide lower returns than retirement investing.
Investing for your retirement
Retirement investing is the other way you can build a pension. Again, the name says it all, you invest to accumulate an amount that will be paid out at retirement age.
As with bank savings, you can do this under certain conditions, and again, you get tax benefits if you invest for retirement. But instead of an amount in a savings account, your money is invested during the term.
That means, of course, that there is no guaranteed return by the time you retire. And again, the amount is paid out over a period of time.
The benefits of retirement investing are:
- Usually a higher amount than when you go bank savings
The disadvantages of retirement investing are:
- Your money is fixed until retirement age. You can “buy out” this earlier, but there is often a penalty fee attached.
- You have no certainty about the amount invested.
Want to learn more about retirement investing? Watch our workshop back.
What is annual space?
The tax benefit, of course, makes it very interesting to build up a pension. But there is a max to what you can build up there. Otherwise, you might use all your savings to say tax-advantaged money aside. That max is called annual allowance. The tax benefit you get applies only if it falls within your annual allowance.
How high is your annual allowance?
Your annual margin is based on your gross salary is a maximum of €13,570 in 2022. You can use your annual allowance up to seven years back. That means you can also use any deficit you had seven years ago to supplement retirement.
Read this article to learn more about annual leave
How do you know how much pension you need?
That, of course, is the key question, how much pension do you need?
There is not really 1 answer to give because this has to do with your lifestyle, but we can tell you what to consider. Anyway, we can share a maxim with you: the government recommends building up at least 70% of the average gross salary earned in your working life. If you receive 70% of your gross salary earned per month in retirement after retirement age, you will not have a huge gap in income.
Costs when you are retired
First, you need to figure out what are your expenses when you retire.
We personally find it easiest to start with an overview of your current spending pattern each month. Do that times 12 and you have a starting amount. But also consider what other ancillary costs you have each year. Such as going on vacation, maintenance costs of your car or house, etc.
If you have an annual amount in your head, consider how many years you have left until retirement age and calculate inflation. That averages 2% per year (with exceptions).
So if you have 20 years left until retirement age, you multiply your annual amount x 1.02 and the result of that multiplies by 1.02 again. Until you’ve done that 20 times. Yes, this works the same as compound interest.
Now you have the annual amount over 20 years, taking into account inflation.
But: it is time to adjust that amount to the possible situation 20 years from now.
You may not want to have to pay a mortgage then. Most likely, you will no longer have childcare costs. Maybe you have a passive income source. Play around with different scenarios and you’ll end up with very different annual amounts.
Elfin helps you create a financial plan for yourself. See more about elfin membership here.
Income when you are retired
When you are retired, you have at least your AOW as income and in addition your accrued pension. You can also receive passive income streams, and you can even continue working after retirement. You won’t then be cut from your state pension or accrued pension, and you’ll pay a different rate of income tax than before retirement age (a lower rate).
The important thing is that that income added together ensures that you can pay your expenses.
What happens if you have a pension gap?
If you have a pension gap, you cannot pay your expenses from income. So your pension is not adequate enough. That may mean living more frugally and/or continuing to work for income. In addition, you may need to start tapping into other assets such as excess value of your home. So a pension gap is what we most want to avoid, which is why it is important to get serious about building a pension as early as possible.
When do you start building your own pension?
If you are working and you are over the age of 21, you can start building up your pension. And although it will be a very long time before you actually retire (you have just started working), it is wise to start doing so early.
The longer your money can pay off, the better. Ultimately, the time you put into building your retirement is one of the most important factors for success. The longer your pension can use interest on interest, the more growth you will have at the end of your term.
In short, retirement seems very far away and therefore not important, but starting early will benefit you immensely later in life.
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