How much income will we need when we retire? – Part 1!
This blog started with the realisation that the day would come when I would actually like to give up work, and that my pension is forecast to give me nowhere near enough money to live on when that happens. How much I will need to live on, and how much I should be saving a month, are the key questions I need to answer, and this is my main goal for this month.
I started by thinking I’d break this down into logical stages, starting with working out how much income I’ll need, followed by how much I’ll get from the state pension and current pension savings, to work out how much of a gap there is and how it can be addressed. This was a nice sensible plan that ended badly. I have a tendency to over-analyse things, and ended up drowning in detail, demotivated, and fed up having wasted several hours of my weekend.
I read about how to draw up a retirement budget – what to include (extra cash for heating and hobbies?) and what to exclude (mortgage payments, work-related expenses such as commuting costs?). I looked at tables on how to adjust this for inflation, and how to work out any shortfall once I’d added in forecast state and other pensions. Then how to calculate savings to meet that shortfall by estimating how long I might live, growth rates of those savings etc. etc. By this point I had had enough. There is a reason I’ve discovered why general rules of thumbs apply – to save us wasting precious hours and being no closer to knowing where we are. By all means do the detail if you wish – I may myself at some point – but if you want a rough idea then start simple!
Keep it simple
My advice is to gather a few key pieces of information: your current gross and take home pay; the amount of state pension you are likely to receive and at what age (see my earlier post); and some details on any other pensions / savings for retirement you currently have – current value, current contributions, and what they are forecast to pay you per year in retirement and at what age. This does mean getting up and finding your latest payslip and pension statement, but that’s all you’ll need.
Now you’re set.
The rules of thumb
The most common rough suggestions for the amount of income you’ll need in retirement are as follows:
- 50% of your current income – this seems to be considered the minimum you’ll need for a comfortable retirement.
- Two-thirds of your current income – this seems to be the most common guideline to maintain a similar lifestyle to now.
- 80% of your current income – Alvin Hall in his book ‘Your Money or Your Life’ is one adviser who recommends aiming for 80% of your current income if you find it too daunting to work out a detailed retirement budget.
- The Money Advice Service suggests a range from 50% to 80% based on your salary, with those on lower incomes aiming for a higher % target income in retirement. They suggest for those with a salary up to £12,199, you’ll need 80% of that in retirement; £12,300 to £22,399 salary you’ll need 70% income in retirement; £22,400 to £31,999 salary and you’ll need 67%; £32,000 to £51,299 you’ll need 60% income; and £51,300 and above you’ll need 50% income.
The amount we’ll each need will obviously vary depending on what our plans are – if you’re frugal you’ll need a lot less than someone who is planning luxury holidays, so only we can know where on the scale we’ll sit.
I plumped for two-thirds as a rough figure, but I don’t think it matters too much which option you pick to begin with. There are so many assumptions used to plan 20, 25 or 30 years into the future that it’s almost impossible to predict with any certainty what will happen. However, it will give you a guideline.
Pick a retirement income calculator
This is where I discovered I’d need part 2 – I had no idea there would be so many out there! I suspect different retirement calculators will vary quite a bit based on different assumptions. For now, just pick one of the many retirement income or pension calculators available online and see what you get! Armed with just 3 of the key pieces of information above (take home pay, state pension income, and forecast pension age and amount from my company pension), along with my chosen income level of two-thirds (though I also jotted down what 50%, and 80% of my current take home pay are also so I could see the difference), I launched myself into Age UK’s version.
This looks slightly out of date as it doesn’t take into account the new flat-rate state pension age, and the assumptions say it’s based on the tax system as at 2013–2014, but I still liked this calculator as it pre-populates many of the fields so you don’t need to make too many choices along the way. In 5-10 minutes you have your information.
Step 1 – you enter some basic personal details including date of birth, retirement age of any pension schemes you have, and say which of five income bands you fall in (these are different from those used by Money Advice Service).
In step 2 you estimate your retirement expenses in today’s money. The various categories such as food, clothing, are already pre-populated based on your income band in step 1, so you can amend any category as you wish. I just adjusted upwards the ‘other’ category so that the total monthly spend was two-thirds of my current income (it was actually very close anyway). The page automatically calculates both the annual income you’d need after tax to have this level of spending, and the target annual income before tax. I think it’s useful to jot this down, as I suspect other pension calculators might work backwards from gross income you want in retirement.
Step 3 moves onto your pension savings to date. It pre-populates the weekly amount from the state pension at £115.95 which it says is the full state pension most people get, but I changed this to the new flat rate pension of £155.65 that came into effect last week on 6 April. I have yet to request a state pension forecast but see no reason why I won’t receive this full amount – you can read my earlier summary of the new system here. You add in any other pension or savings you expect to receive and then, the moment of truth, step 4 tells you if you are on track…
…well of course it isn’t in my case! It gave me a likely income and a shortfall figure for two scenarios, retiring at 65 which is the date of my company scheme, and age 67 when the state pension kicks in, alongside a figure for how much extra I need to save per month. If I retire at age 67, I had a pleasant surprise – yes I’d have a shortfall of 20% if I wanted two-thirds of my current income, but could retire on half of my current income. Our rules of thumb say this would cover the essentials, though give me nothing to play with. However, if I retire at age 65 when I’ve yet to receive the state pension, I’d be facing a 60% shortfall to retire on two-thirds of current income. If I want to hit my target of two-thirds, I need to start saving over £300 extra month.
Step 5 is where you can play around with variables to see what impact it has. Some surprises again, as I can see just how much extra I would need to do if I retire earlier than 65 (I’d like to). To take just 5 years off my retirement age to 60, I would need to more than double the extra savings required to £700 per month. That’s an extra £700 per month, above what I’m already saving, every month, until age 60. That’s a lot, and not at all possible at present. However, on a more positive note, it told me that if I reduced my target income to 50% of current income, apparently I would have enough to retire on at age 65 with no extra savings. I have to confess, I’m a bit confused by the figures, in particular those where I change the target income. I’ll need to check out some other calculators to see how they compare.
Step 6 is where you get a summary of the above, and you can save the results to amend at a future point in time.
Key points to bear in mind with the Age UK calculator is that it assumes all savings are used to provide an income – so if you’re thinking you might take a 25% tax free lump sum from your pension and spend it on a fancy car and holiday, think again. It assumes you’ll use the lump sum to provide an income. It also assumes inflation will be 2% a year, that you’ll buy an inflation-linked annuity at retirement, and that annuity rates will be the same as now. Any extra savings you make are assumed to rise in line with earnings, assumed to be 1% more than inflation. Invested pension savings are assumed to rise by 5% a year before charges, invested non-pension savings to rise by 4% a year before charges, both with charges of 1.5% a year (pension to reduce to 1% after 10 years).
More pension calculators! Working out retirement income is obviously open to wide variations because of the length of time between now and then, with different assumptions potentially making a big difference.
However, I now have some figures to work with as a starting point. I have a rough idea by how much I need to increase savings each month in order to be able to get closer to leading the type of lifestyle I would like when I retire. Also some idea of by how much I might need to start adjusting my expectations to more closely match reality and still be able to enjoy life now. More to come in part 2 next week!
Images: Pixabay: geralt