How much money do I need to retire?
You want a comfortable and secure retirement, but how much money do you need to save in order to ensure this?
Marketing material from pension and investment companies often features prominent stock photography of older people with brilliant white hair and teeth, dressed in breezy white linen, strolling along the beach or clinking glasses of bubbly.
Sounds great, but is it a realistic expectation? The year before retirement can be a period of great uncertainty: How much income will you have? How much will your desired quality of life cost? Have you saved enough?
How much will I need?
This is the difficult question. How much you will need to have saved depends on numerous factors, including investment growth, inflation, annuity rates and more. How much you need will depend on how much income is required to fund the quality of life you want in retirement.
But it is possible to get a general idea.
According to pension provider Aviva, in order to maintain a post-tax income of just under £20,000 per year (for a comfortable but not quite luxurious lifestyle) including the state pension, a healthy 65 year old will need a pot of £250,000 for an annuity today. If they want their spouse to get half of that income after they die, a joint-life annuity will pay out a few grand less than this.
What is an annuity and how does it work?
An annuity is a retirement product you can buy that guarantees a set income for life. The amount you get will depend on what you have saved and the annuity rate, which determines the percentage of the total pot the annuity provider is willing to pay you per year until you die. Simply put, if you have £100,000 and the annuity rate is 2%, you’ll get £2,000 every year for the rest of your life.
If you pay more, you can get more frills. An index-linked annuity, for example, guarantees that the income you get will increase with inflation. If you’re lucky, retirement could be decades long, and inflation could erode a lot of your buying power in that time. Think about what you could buy for a tenner thirty years ago.
A joint-life annuity will pay out to you and one other person, only ceasing when the second party dies.
An index-linked joint-life annuity is a product that is guaranteed to pay you a certain income, which rises with inflation and only stops when you and one other person (usually your husband or wife) dies. In this case, Aviva estimates that in order to buy a joint-life annuity that starts at £9,000 and rises with inflation, you’ll need a pot of £250,000. For most people, this would not be a high enough income so you would want to have saved substantially more.
Alternatives to an annuity
You don’t have to buy an annuity though. You can also go into income drawdown, whereby you withdraw an annual income directly from your pot, which remains invested. This is riskier than an annuity because you will be exposed to fluctuations in the markets and you could run out of money early if you’re not careful.
One rule of thumb espoused by some is the “4% rule” – although calling it a rule might be a bit misleading. It suggests that 4% is the highest sustainable withdrawal rate from your pension pot, meaning that 4% is the most you should take out if you want investment returns to backfill what you have withdrawn. If you take out too much, you risk diminishing your pot, which would then have to work harder to provide you with the income you want. By taking out a sustainable amount, there’s more chance of investment returns growing enough such that you won’t run out of money.
If you want a pre-tax income of £20,000, not including the state pension, the 4% rule would suggest that you have half a million pounds saved.
How much do I need to be saving?
The headline figure may appear daunting to anyone just setting out to begin saving for their retirement. However, don’t let it put you off: the worst thing you can do is not save at all. As the saying goes, the best time to plant a tree is 20 years ago; the second-best time is today.
A quarter-million milestone is achievable, although the later you start saving, the more you’ll have to put away. Remember, if you are saving into a workplace pension scheme, your employer might be matching your contributions (at the very least – some employers go above and beyond by contributing more than their employees). Also, when you contribute to a pension you get a free tax top-up from the government, which effectively pays you back the tax you would have already paid on your contributions. If you are a basic-rate taxpayer (paying 20% tax on income), this equates to a 25% boost to your contributions.
Pension provider Royal London recommends someone who starts saving at age 25 should put away a minimum of almost £300 per month in order to avoid a severe drop in their standard of living after retirement.
What about the state pension?
Remember also that the state pension will supplement the income you earn from whatever you’ve saved. Don’t plan to rely on it solely though, as government policies can change from one government to the next and the state pension is currently very expensive for the government.
The important thing is to save as much as you can. Maximise your workplace contributions to get as much of that tax money back as you can. Also consider the pension benefits when you are choosing your employer (if you have the luxury of being able to choose).
The sooner you start contributing, the sooner you will stop noticing the money going away.
Saving for retirement is no joke. The amount you need to be sure of a comfortable post-work life is quite large. However, anything is better than nothing. The worst thing you can do is continue to postpone saving. Take advantage of what your employer offers, put as much away as you can afford and get those returns compounding upwards as soon as you can.
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