This must be one of the most common questions financial advisers get asked. Everyone knows that they need to save for retirement, but the big question is “how much?” I have come across many different formulas for the calculation. Some are quite good; others seriously flawed. Let us see if we can shed some light on the subject.
What is your target income?
The first thing to think about is your target income at your desired retirement age. It helps to have an imagination and to visualise yourself in retirement. Will you be active? Or sedentary? Retirement can be viewed as one long endless holiday and your spending plans should be considered accordingly. Genuine retirement means stopping work completely – so how much would you need monthly to be able to retain your standard of living?
I can’t answer that, as this is very much a personal thing. If you are struggling for an answer, the 50-70 rule might help. This suggest that you should aim for an annual income of between 50% and 70% of your working income. If you earn £50,000 for example, you’d want to achieve somewhere between £25,000 and £30,000 per year as your retirement income. A more accurate way would be to estimate your expenditure in retirement and aim for an income that would cover your expenses whilst leaving you with enough of a surplus to cover the unknown.
What is your retirement age?
The current state pension age is 66, scheduled to rise to 67 between 2026 and 2028 and potentially to 68 between 2037 and 2039. The state pension age is kept under review which means that it could change in the future. For most people, pensions become available at age 55 and your personal retirement age could be any age between 55 and 75.
The important thing to consider, whatever age you choose to retire, is how much you’d need to live on. Retiring earlier would mean having potentially less time to build your savings, making it more of a challenge. Conversely, retiring later would mean having a longer period to save, making it less of a challenge. Either way, it is important to start saving for retirement at as young an age as possible.
What is the formula?
One easy way of figuring out roughly how much you should pay into your pension each month as a minimum, would be to take the age at which you open your pension account (let’s assume age 40) and divide this figure by two. The result, (in this case 20) is the percentage of your pre-tax salary that you should be paying into your pension pot until you retire. This assumes you retire at state pension age.
Using this formula, a 40-year-old earning £60,000 per year should pay 20% x £60,000 = £12,000 per year or £1,000 per month as a minimum. This figure should be adjusted with salary increases and inflation. You’d have to speak to a financial adviser if you’d prefer a more accurate income calculation. Your financial adviser would have tools to enable them to factor in things like inflation, investment growth rates, risk, stress tests such as stock market falls and events like time off work and contribution fluctuations.
Most importantly, the earlier you start saving, the better. The best time for you to have started saving for retirement was probably a good few years ag. The second best time is now.