I’m really enjoying your podcasts and have already given a 5 star rating.
I am 57 and plan to retire at 60 so love your retirement items.
When talking about 4% draw down or retirement income, it’s never clear if the figures are before or after tax. For example 4% of £1m is £40k, but after tax this could be nearer £30k.
If you then get a state pension of say £9k, the figure before tax is £49k, byt after tax it is nearer £35k.
So when you talk about money needed in retirement, do you mean before or after tax?
David, thanks so much for the review! I definitely appreciate it.
First things first, David I am sorry that it’s taken me ages to get a blog post done on this, however, I did respond to your question directly within 24 hours of you asking it so I hope that will make up for the late blog post response to your question which you asked me roughly 3 months ago and 4 months ago by the time this airs on The Money Spot podcast.
Turning to the 4% rule…
For those that have not ever heard of it, the 4% rule states that if you don’t want your pot of invested retirement funds to run out before you die, the maximum you can take from that pot each year is 4%.
This means that if you want an annual income of 40,000 from your retirement pot, you need to save one million (GBP, USD, EUR) – I believe the study was done using American stock market performance but if you invest in a global portfolio it will be heavily weighted towards the US so you can use the 4% rule as the best proxy we have on what a reasonable withdrawal rate is.
To answer, David’s question, the 4% drawdown is gross and you would have to pay tax after that.
So, if you have £1,000,000 (for simplicity) in your pension pot in a given year, you would draw £40,000 and pay the tax on that.
If you are based in the UK, you cannot throw the gross amount drawn from your SIPP or other taxable investment account into listentotaxman.com to get a calculation of your after-tax income because your drawings from your investments are chargeable to capital gains tax so you don’t pay income tax on them but capital gains tax. Capital gains tax rates are different. In 2020, assuming 50% of the £40,000 you draw is capital gains, then your net income after tax would be calculated as follows:
Not taxable: £20,000 (this is the portion you actually saved)
Taxable: £20,000 (the capital gain)
Deduct capital gains tax allowance: (12,300)
This taxable amount all falls into the basic rate band for 2020/21 so you’d pay tax of 10% on it, i.e. £770. If you had a portion in the higher rate tax band even that is only taxable at a rate of 20%.
So, out of the £40,000 the net amount received would be £39,230.
This is a huge different to what you would have paid if this was income of £40,000 as the net income would have amounted to £30,841. That’s a difference of £8,389 – wow! People on work place pension will be taxed in that way because the DB pension counts as income, you can’t separate it into capital and capital gain.
If you are UK based and have reached your state retirement age then you would have an annual state pension. This is taxable to income tax and you can throw the total annual state pension amount that you receive into listentotaxman.com to figure out how much you will receive after tax.
State pension is taxable if all your sources of income sum exceed the threshold needed to pay tax.
That annual state pension is just over £9,000 so if that’s your only source of retirement income you wouldn’t pay any tax because it’s below the personal allowance of £12,500 – however, if this is you, you probably wouldn’t be the type of person that listens to personal finance podcasts - #JustSaying.
A few BIG things to remember though:
If your retirement income is all in your ISA then it is all tax free; not tax needs to be paid.
Capital gains tax allowance
Current tax rules allow you to have a tax free allowance on capital gains in addition to the tax-free personal allowance SO your tax bill may be much less than you think because your state pension and any other pension income may fall into the regular income bucket and this enjoy a separate tax free allowance.
For 2020 the Capital Gains tax-free allowance is £12,300.I don’t know if this will be available when I retire, there’s talk of eradicating it to raise more tax…
Those that retire very early, and I’d classify anything before 55 as early may be overdrawing if they draw 4% because the study of the 4% rule was based on a 30-year retirement.
David, you’re probably okay given you’re 57.
Sequence of returns risk
Sequence of returns risk analyses the order in which your investment returns occur.
If a high proportion of negative returns occur in the beginning years of your retirement, these negative returns will have a lasting negative effect on the balance of your investment portfolio and the amount of income you can withdraw over your lifetime is reduced. This is sequence of returns risk. However, if you have a few years of good returns when you retire and negative returns only occur later, say in the middle of retirement, then there’s a lasting positive impact.
If this happened to me, I would probably stop drawing income from my retirement pot for 2 or 3 years and live off non-stock market income, e.g. if you have cash pot set aside, I’d deplete that first; or I’d consider getting a part-time job; or for those fortunate enough to have rental income, you can live on that and give your investment portfolio time to recover.
I think that’s all the main stuff. To summarise:
I hope this answers all your questions and I additionally hope that I threw in a few thoughts that you hadn’t considered.
p.s. subscribe to my podcast and ask me any money question, HERE - do it now!
When is a good time to draw equity from your house: when I retire which is in about 5 years or before?
Thanks for this question because it really got me scratching my head.
I was initially quite flummoxed when I received the question because as a proponent of the FIRE movement (Financial Independence Retire Early) the whole premise of my money management toolkit is to get out of debt including mortgage debt completely and NEVER go back. However, I am going to park this way of thinking and answer your question in the most unbiased fashion that I can and I will also ask you a few probing questions so you can figure out whether this is what you want to do.
FIRSTLY, what do you plan to do with the money? Do you want to use the money for general living or to make a significant purchase or investment?
Generally, I think in most cases it is not a good idea to get into debt during retirement as it may cause undue stress if you run into any unexpected financial problems.
OPTION 1: Take equity out and pay off the debt or interest during retirement
I don’t know the value of your home or any other numbers, however, if you take equity out of your house that money will be charged interest and if you enter into a standard mortgage contract, you will have to pay the interest and possibly repayments from the month after you take that equity out.
From my follow up email to you I gathered you have a pension that will come in when you retire. I am assuming this is a “defined benefit” pension so it’ll be paid to you from retirement until you die.
By taking on debt you will have a reduced income. So, if your pension is income amount to 2,500 per month and if you take out equity requiring 500 in monthly payments you will lose 20% of your pension straight off the bat to debt payments. How will this affect your standard of living?
OPTION 2: Take equity out and pay all the interest off when you die
If you are over 55, which I assume you are, you can also get a mortgage that doesn’t require interest payments to be made until you died.
Depending on the terms you may be allowed to repay some or all of the amount borrowed. Otherwise, with a lifetime mortgage all the interest would be accumulated and paid on your death.
So if your home is worth 100,000 you might sell a 40% stake to the bank for a 20,000 lump sum. When you die, the bank gets 40% of whatever the house is worth at the point. So if you die 20 years later and your home is worth 300,000 the bank get 40% of 300,000 which is 120,000 for the 20,000 that they lent to you.
If you died the very next year and your house has stayed the same in value then the bank gets 40,000 for the 20,000 that they lent to you. Even if your house falls in value the bank is still likely to come out ahead because they take a huge hair cut off the value of the house.
The reason these mortgages are only offered to people over a given age is to minimise the chance of the bank losing its money, for example, because accumulated interest exceeds the value of the house on a lifetime mortgage.
To safeguard the bank further, they keep the amount of equity that can be released quite low; the younger you are, the lower the allowed equity release. So, a 55 year old might be restricted to releasing no more than 20% but a 75 year old might be allowed to release 30-40%. I am making numbers up here because the reality is that more conservative banks will have lower limits and banks that are more risk tolerant allow a bigger release of equity.
It all sounds great on first inspection but banks have received a lot of bad press regarding equity release schemes because in the fine print they have stuff like, you don’t need to repay the interest PROVIDED you live in the house so if you need to move home, even into a care home or to a more accessible home because you develop mobility issues, all that money comes due and you would be forced to sell your house and pay the bank.
There are likely to be other catches too because banks are in this to make money so if you go for an equity release scheme of any nature you should have a lawyer or financial advisor look at the terms and conditions diligently for you so you know exactly what you are getting yourself into.
The bank might get a guarantee that you will never owe more than the value of your home but this means that you could owe the full value of your home to the bank. If you release equity at age 55 and live until 95 there is every chance that interest can accumulate to the point of exceeding the home value.
It’s nice to get a tax free lump sum via an equity release but in doing so you may reduce your entitlement to means-tested state benefits, now or in the future so you need to think about this angle too.
I don’t know how well I am doing with the unbiased view thing here as you can probably tell that I think releasing equity is a high risk game and it frankly, freaks me out.
If you don’t have any kids or charities/causes that you’d like to leave an inheritance to and you’re certain you will be physically fit enough to live in your home until the day you die then perhaps the risk of releasing equity could be worth it.
Another form of equity release is to downsize your home, i.e. you sell an expensive home and buy a cheaper home and live off the difference, this way you release equity but don’t incur any debt in the process.
COST OF EQUITY RELEASE
According to moneysaving expert.com, a lifetime mortgage equity release typically has an interest rate of c.5%, but some rates are under 3%.
This is a lot higher than rates on regular mortgages. E.g. With a 40% deposit you can now get a 5 year fixed rate mortgage of just under 1.4%, just to give you an idea.
If you release equity at a rate of 5% then the amount you owe would double every 14 years (see my article on the rule of 72); so if, say, you borrow 20,000 on a 120,000 home, if you live until 74 you’d owe around £40,000, live until 88 and you’d owe £80,000 and live until 102 and you’d owe 160,000.
As well as the cost of the interest, don’t forget that you'll have to pay arrangement fees when you take out the mortgage and in the UK these range from £1,500-£3,000 depending on the mortgage deal and including things like solicitors and surveys.
As you have 5 years until retirement, you could try to boost your savings over the five years so that rather than borrow money you’ve saved for it. If you don’t feel you earn enough to save the amount you want you can look at things like renting rooms in your home via AirBnB or by getting a more full time lodger.
I would personally find it very scary to go into retirement with debt because the need to keep with payments or even the knowledge that I don’t actually own my home but if you are more comfortable with the idea then this won’t be a consideration for you.
My biggest advice would be get professional advice before you take this massive step and do whatever you can to avoid having to do it. A debt-free retirement is a peaceful retirement.
Much love and thanks for being a long-time follower. See the linked article on equity release on the moneysavingexpert.com website.
p.s. subscribe to my podcast and ask me any money question, HERE - do it now!
Hi Heather, just discovered your podcast and blog. Really inspiring. Could I ask a question?
I have about £10k to invest and I’m considering three options. I’d really appreciate your help in deciding what to do.
Any advice would be hugely appreciated.
I apologise for the delayed response as I realise your question was time-sensitive but I was in project execution mode over the last two weeks.
I think this is an awesome question and I’ll tell you how I would go about thinking about this. Firstly, did you know that I too am a civil servant with access to the Alpha pension scheme? Let me know via the comments box if you did know. I have never mentioned it in any blog or podcast before but it is on my LinkedIn.
Given what you have said about when you could access your SIPP, I am guessing you are about 43 years old, i.e. you have 12 years to reach age 55 when you can access the SIPP and if your retirement age is 67 then you have 24 years until you can access your Alpha pension savings.
There are 4 keys things you might want to consider:
By portfolio effect I mean you should consider how the lump-sum is invested in the context of other sources of income you expect to have in retirement.
Firstly, I opted out of the Alpha pension scheme because my husband works for the NHS and has access to their defined benefit scheme and because we manage our household finances as a single unit, I felt we could take more risk. His NHS pension gives us a safety cushion and I went for the civil service partnership pension which works exactly like a SIPP in that what I get at retirement depends on the return. An added benefit is that I can access the money at age 55 rather than 67 if I want to although I doubt I would do that as I’d rather use up my ISA savings first.
Average stock market returns have historically been about 10%. This could be the same in the future or it could be different. There are no guarantees.
I am not sure what your passive investment portfolio is specifically invested in but I will assume it is a passive global fund and as you haven’t said it is in an ISA, I will assume it’s in a taxable investment account. The last time I looked for a reasonable return to use to model my future returns I found an article that suggested 9% gross and 6% net of inflation was reasonable. I prefer to use 7% gross and 4% net of inflation.
If we go for the 7% return in taxable brokerage account – i.e. ignore the SIPP option to begin with:
If you drew the money down according to the 4% rule which says that you should draw no more than 4% of an invested portfolio so that it doesn’t run out, then if you start to draw on this money from age 67 (same as when you would have access to your Alpha pension money) you would draw £2,028 in the first year of retirement (50,700 x 4%).
The following year when you are 68, you would draw £2,083 i.e. (50,700-2,028) x 1.07 x 4% - you draw slightly more because although the money has been drawn it is still invested and continues to grow at the average rate of 7%.
These are gross numbers – what about after inflation?
If you wanted to look at what you would be drawing after inflation, then in the equivalent of today’s money you would draw £1,024 (25,600 x 4%) and you would draw slightly more in real terms the following year.
You need to compare what this looks like against Alpha.
I know Alpha is inflation protected but I am not clear whether the £1k increase in Alpha payments that you mention is from today or whether it’s £1k from the age of 67 and growing from inflation at that point.
If it’s £1k and growing with inflation from today then at the age of 67 you would be getting £2,030 in real terms (1,000 x 1.03^24) whereas with the stock market investment you were getting only £1,024 in real terms – from this perspective Alpha is a no-brainer as it’s a guaranteed £2k per year until death rather than a probabilistic gross drawdown of £2k per annum.
I see the stock market as broadly providing some inflation protection given all companies increase the prices of their products over time.
If it’s the case that the increase in the Alpha pension is £1k at age 67 then growing by inflation from that point then the additional gross £1k in real terms after 24 years is only £490 (1,000) / (1.03^24) – in this case the stock market investment looks much more attractive.
If you go for Alpha with self and dependents then multiply the Alpha benefit by 90% to evaluate the impact.
If we go for the 7% in a SIPP account – then you get an immediate uplift because there is an immediate tax saving.
As a higher rate tax payer note that the SIPP provider would only claim tax relief at the basic rate of tax and you would need to claim additional tax relief via your self-assessment tax return or if you don’t do a tax return you would need to call HMRC to see if you could just do it by changing your tax code.
With the full tax relief £10k translates to £16,667 in your SIPP.
If you drew the money down according to the 4% rule, then if you start to draw on this money from age 67, you would draw £3,380 gross (84,530 x 4%) or about £1,700 in inflation adjusted terms and steadily growing.
From a returns perspective putting the money into a SIPP begins to look very attractive indeed. This brings us to the next consideration, horizon/flexibility.
HORIZON / FLEXIBILITY
With a SIPP you have access to the money from age 55. Unless you are 100% sure you don’t want to retire before age 67 or even to part-retire then you don’t need earlier access to the money.
With the money in a taxable brokerage account you can draw the full gross amount invested in one go, if you like. There would be tax to be paid but you would still have the full amount if you wanted it.
You can reduce the tax amount due from a full drawdown if you put half i.e. £5k into your own investment account and half into a spouse’s investment account. You can avoid tax completely by putting the full £10k into an ISA (the annual limit is £20k so you would be within that).
If you have all your assets in a defined benefit pension plan then your dependents don’t have access to those assets except to the extent defined by the plan. For Alpha, if you die before your spouse then I believe your spouse continues to get 37.5% of what you would have got and children only get a benefit if they are under 18 or under 23 and in full time education.
With a SIPP your family gets everything invested and under current tax law money sitting in a pension is protected from inheritance tax if you die before the age of 75 (this could change given the tax rules are constantly changing).
So, as basic example, if you died at the age of 67– in 24 years just before you could claim any pension, if your 10k had been invested in:
I apologise that this response is so full of numbers but this is essentially all the things you need to think about and the numbers are pretty important when we are thinking about pension and retirement options.
If having access to a few pots of money before the age of 67 is important to you or if passing on some cash to dependents matters, then Alpha is not attractive.
If you are risk averse and want to ensure you have a comfortable, guaranteed inflation-linked pension pot then plough the £10k into the Alpha pension plan as this would suit your risk tolerance better.
I hope this helps!
Have a money question for me?
Thank you so much for launching your podcast. I am really enjoying all your advice.
My name’s Vivienne. I’m single and in my late 60s. I receive the state pension and find that I struggle to make ends meet – my saving grace is that I own my home outright but I don’t have any other investments outside of that. Although I would like to work because I get lonely sometimes, I lack the energy I used to have in my younger days and certainly I find a full day’s work very exhausting nowadays. Is there anything you can think of that can help me boost my income?
Thanks for this question Vivienne.
Given you are not working, I won’t give you advice about saving and investing at this stage as I normally would.
I’m sorry you get lonely – loneliness is a rising issue in Britain and not only amongst older people – in 2016/17 Younger adults aged 16 to 24 years reported feeling lonely more often than those in older age groups according to the Office of National Statistics.
I have two income boosting suggestions for you that could help boost your income and reduce your loneliness too.
In the past, I have also given people advice about boosting their income by monetising any skills they might have on freelance sites like fiverr.com or upwork.com or by tutoring via websites like tutorful. However, I am going to suggest something totally different to you, perhaps even radical: have you considered taking in a lodger or renting out any spare rooms you might have on airbnb.com?
You could do this even if you didn’t own your home as long as you get permission from your landlord to sublet.
There are pros and cons with each option.
Option 1: LODGER
If you take in a lodger, you will have someone living in your home on a full time basis and you will probably have to give up some of your space in places like the kitchen to them. You will also need to be comfortable with that person using your appliances and white goods.
Are you happy for someone to share your hob, your fridge space, your washing machine and your living space that closely.
Taking a lodger in could flip you from being lonely to being frustrated very quickly if that person has very different habits and a very different lifestyle to you.
Instead of a full-time professional lodger perhaps you could take in a more transient lodger like a student. Some students, especially international students don’t see university as one long party and may well be studious, well-behaved and easy to live with.
If the person comes from Europe, they are also likely to go back home regularly leaving you to enjoy your living space on your own terms during such periods.
The government allows you to earn up to £7,500 a year tax free by letting a room in your home. This amounts to £625/month, all tax free.
Given that the state pension currently sits at c.£8,800 a year, you would almost be doubling your income if achieved this amount. If you have a generous spare room with an ensuite you might well be able to charge this kind of rent. Or if you have two spare rooms you can get a couple of lodgers.
You could also exclusively look for someone that is retired with the objective of keeping each other company in retirement. The type of person you decide to let a room to is entirely up to you.
One downside is that you might find a lodger who keeps too much to themselves and isn’t interested in bonding with you which might make you feel even more lonely. This brings me to option 2.
Option 2: AirBnB
Have you considered renting any spare rooms out on AirBnB? If you have the energy to change sheets and provide a breakfast this can be a fantastic little earner especially if you live in a popular city.
However, even if you are in a quieter city it is certainly something that is well worth trying.
A major advantage of letting rooms out on AirBnB is that you will retain full control over your home and kitchen space. When you are not home, for instance, if you are on holiday or visiting friends and family you won’t be leaving the house to a lodger which may offer you some peace of mind.
Just as importantly, during times when you expect visitors such as at Christmas you can have the house free of AirBnB guests.
A key advantage of AirBnb over a lodger is that you will get exposure to many different types of people with many curious about you and your city – based on them having to rent an AirBnB you can assume that most won’t be as familiar with your local area as you are and you can enjoy telling them about it and where to visit.
Personally, if I were in your shoes, I think I would go for the AirBnB option but you should decide based on your own personality and preferences. For instance, you might find the perfect lodger for you – someone who is perhaps older and not transient and even wants to spend time with you.
When I was single, once I bought a house, I always had a lodger for two reasons: firstly, I didn’t like the person I was becoming when I lived alone – I was becoming very rigid and set in my ways; secondly, I needed the extra money because my first mortgage was expensive and the monthly income boost made a big difference to me. I was also very likely to always find lodgers that I had things in common with so we could do some things together.
Just as with getting a lodger, you can rent rooms out on AirBnB and not have to pay tax until you are earning over £7,500.
I hope this is helpful. Outside of this there are the more obvious things like getting a part-time job or baby sitting when you have the energy and inclination to do that kind of thing.
I hope this helps you thinks more broadly about how you can boost your income and get some companionship at the same time.
If you are enjoying listening to my podcast, please give me a 5* rating wherever you listen to podcasts. If I don’t yet deserve your 5*, please let me know how I can earn it.
I hope this helps!
Have a money question for me?
My name’s Linda. I would like to have a comfortable retirement but I am not sure how much money I need to have saved up in order to achieve this goal. I am not particularly extravagant but I do want to be able to afford at least two holidays a year. I additionally don’t have access to a fixed workplace pension so I need to live within the means of my own investments and the state pension. How should I go about working this out?
Thanks for this question Linda.
There are a few ways to think about this.
Firstly, when do you want to retire? The reason that this matters is that your state pension will only kick in at the state retirement age so if you retire earlier than this you will need to make up the difference from your own investments.
You also need to consider your living situation during retirement. If you are likely to be married or in a relationship then you would have two state pensions coming into the household but not double the costs – for instance, utility bills don’t double with double the number of occupants in a home.
You would also need to factor in that, even if you are in a relationship, one person will probably outlive the other and at that point one source of pension income may be lost.
TWO WAYS TO GET AN INCOME IN RETIREMENT FROM A SAVED LUMP SUM
There are two ways that your savings and investments can be used to secure your income in retirement:
The first way is to buy what is called an annuity. The second way is to just draw down your income slowly over time.
An annuity is a financial product that provides a guaranteed income for life. Essentially, you take a lump sum of money, give it to a financial provider and they tell you how much they can pay you for life depending on the features you want. For example they can give you a fixed amount every month for life, or they can increase that amount every year by inflation, if you want an annuity that grows with inflation the starting amount will be smaller than if you go for the fixed amount. You can also buy an annuity that covers one person’s life or two people’s lives, that is, once the first person dies the annuity continues to pay out until the second person named on the annuity also dies.
Annuities used to be popular in the past but because interest rates have fallen drastically since the 2008 financial crisis they have not been so attractive.
How much would you need if you were planning on retiring today, were getting a state pension and were planning on buying an annuity?
According to this is money who in turn source a report by Royal London, you would need £260,000.
“Royal London’s sums were based on the amount needed to bridge the gap between an £8,500 state pension and two-thirds of the £26,700 average salary.”
Two-thirds of £26,700 is £17,800. This means Royal London are assuming that you would live on £17,800 every year: £8,500 of this would be coming from the state pension and £9,300 would be coming from the purchase of the annuity. These figures suggest the annuity is giving a return of just 3.6%.
In my opinion, that’s a very poor return and not even worth getting the annuity.
This is money also confirm in their article that if you plan to retire in 30 years’ time rather than today, this £260,000 becomes £400,000 and this further assumes that annuity rates improve by then.
If interest rates are just as low in 30 years’ time as they are now and if we assume average inflation of 3% per year (which is what it has been historically), then instead of £260,000 you would need £630,000.
Personally, I do not recommend the annuity route AT ALL. If you are happy to take a little risk then you would be FAR better off just drawing on the invested money.
The most popularized rule for drawing down on your invested pot is the 4% rule. The 4% rule essentially says that if you drawdown 4% of an invested pot every year, you are unlikely to run out of money over a 30 year period. While the study that came up with the 4% rule used 30 years as the period during which a person would be retired, the general conclusion is that even at the end of that 30 years the money invested will have grown because the average drawdown rate of 4% is lower than the average growth rate of your investments.
So, for example, if your investments grew by 7% in the last year then taking 4% means you are still ahead.
The beauty of drawing down rather than buying an annuity is that whatever is left when you die can be passed on to children, charities or whatever you choose. With an annuity, the payments die with you. For example, if you bought the annuity of £9,300/year today and died next month, tata £260,000 – that’s it. The full benefit of your early demise goes to the financial institution that sold you the annuity in the first place. Rubbish, right, well that’s what you get for playing it too safe!
If we take the £260,000 lump sum we have been using and continue with it for example purposes, then a 4% drawdown would produce £10,400/year in the first year which is better than the £9,300 you were getting from the annuity that ‘this is money’ talked about. Not only that, in the following year it could be that you will base the drawdown on a bigger number than £260,000 because the investments will have grown in value. The average growth rate of the stock market over the last few decades has been 10% before accounting for inflation. Of course, this says nothing about the future as stock market returns in the future could be better than or worse than this.
Rather than working backward from what income a given lump sum will give you? Let’s figure out how much you will probably need to spend in retirement, that is, let’s work out your desired retirement income.
Once we have your desired income we will subtract income from your state pension and any other pensions.
We will then divide the gap by 4% and this will give you the value of investment assets that you need.
I’ll share two sources that I have found for trying to work out how much money you will need each year in retirement.
SOURCE 1 – on how much money you need for retirement
“According to research carried out by Loughborough University and the Pensions and Lifetime Savings Association (PLSA), workers who only manage to save enough for a retirement income that provides them with £10,200 a year (£15,700 for couples) will achieve a minimum living standard, those who managed to save enough for £20,200 a year (£29,100 for couples) will be able to live a moderate lifestyle during retirement and those who are able to save enough for £33,000 a year (£47,500 for couples) will be able to enjoy a comfortable retirement.” (source: moneyfacts.co.uk)
This £33,000 a year (£47,500 for couples) includes holidays abroad, a generous clothing allowance and a car.
These are the lifestyles that the Loughborough University and PLSA study creates:
I don’t know about you but I would like to target the comfortable lifestyle or better!
Using the 4% rule, if you are targeting a comfortable lifestyle then:
Before you give up before you’ve even started because these numbers sound too hard to achieve, keep listening, I’ll give you an example at the end of how much you need to save now and it will sound much more achievable.
If you are targeting a moderate or minimum living standard, you can calculate the equivalent numbers by following this formula:
As a reminder, the full state pension is currently £8,767.20 per year but I used £8,500 in my examples for simplicity.
If you plan to retire based on the minimum standard of living at say 60, then when you start getting the state pension as well if you are a single person, you would be boosted to close the moderate living standard; and if you are in a couple, you would be boosted just beyond the moderate living standard by receiving two state pensions – assuming both people are entitled to the full state pension or close.
SOURCE 2 – on how much money you need for retirement
Using a report from the Joseph Rowntree Foundation, a respected charity, Fidelity.co.uk allows you to start of with a basic standard of living which costs £16,300 and allows you to add annual costs to this depending on the lifestyle you want.
This £16,300 accommodates basic rental accommodation, basic costs for food, alcohol, clothing, water, gas, electricity, council tax, household insurances and other housing costs, public transport costs and an occasional visit to the cinema.
The basic £16,300 cost of living assumes a single person not a couple. Within this figure you don’t run a car, you don’t eat out much at all, you don’t smoke and you don’t have internet access or paid-for film channels (I guess you would watch only free channels and have to go to the local library for the internet).
Note that this £16,300 is higher than the £10,200 suggested by the Loughborough University study for a basic standard of living but lower than the £20,200 suggested for a moderate standard of living so we can call it basic Plus.
I would guess the Loughborough study assumes you have paid your home off in their basic living assumption which could explain the difference.
So, how do we boost the £16,300 basic income to improve our life style?
If you added on every single one of these extras, you’ll be at a very comfortable £37,500/year which is not too far off the £33,000 suggested by the Loughborough University study for a comfortable retirement.
This would be equivalent to £54,000 for couple if we increase in direct proportion to the Loughborough study (37,500 * (47.5/33)).
What level of investment assets do you need to achieve this?
You need c.£940k if you are a single person or £1.35m if you are a couple before the benefit of a state pension. This £1.35m is very aligned with the £1.2m we got using the Loughborough University study. State pension income reduces your need to save and invest by about £200,000.
If you keep a budget it might be easy to calculate what your monthly spending in retirement will be; just remove all the things you spend on now that you won’t need to spend on in retirement, like travel to work or rent or a mortgage payment if you plan to own your home outright at the point of retiring.
There are a lot of numbers here but it’s more or less pretty straight forward once you have worked through it systematically. How much do you need to save now to live your ideal lifestyle and to hit your goal by retirement? You’ll need to take the next step and figure that out. If you want me to help you do this, request a call.
As an example, if you are a 22-year old couple now and plan to retire at 67, you only need to be saving £285/month in total into pensions (that’s only £140/each). This has to be into pensions and not into an ISA as I am assuming you get the tax benefit of saving into a pension. My calculation assumes you get an average market return over those 45 years of 7%. If returns average 10% as they have in the last 45 years, you would completely overshoot and end up with a retirement pot of £3.7m – how’s that for compound interest?!
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I hope this helps!
Have a money question for me?
Based on the things you told us about investing, my husband and I started putting £125 per month each into our SIPP pension. I hope this isn’t a silly question but what are these savings for? When can we expect to start spending that money and should we try to spend it in specific ways or on specific things? Both my husband and I are 30, we don’t plan on having children and our jobs have fixed pension benefits.
That’s a great question. While everyone has a different value system, there are two main reasons that I strongly recommend that people put money into a self-invested pension plan or SIPP a) flexibility and b) security including funds to help pay a mortgage off early.
A SIPP can be better than a stocks and shares ISA, in some cases, because you effectively pay less tax and because you can’t use the money until you are about 58 so it forces you to save.
Let’s talk about each reason in turn:
The first reason: is flexibility over when to retire
In the past, a lot of work-based pensions (aka defined benefit pension plans) used to allow early retirement from between the ages of 55 and 60, most of these type of scheme are being completely phased out and are instead being linked to the state retirement age which for you is currently expected to be 68. There is talk of moving this to age 70, so this is a future possibility.
Whatever happens, the funds that you build up in your SIPP can be taken from 10 years before the state retirement age. This means if the state retirement age moves to 70 you will still be able to use money that’s sitting in your SIPP from the age of 60.
If you and your husband are putting £125 each into a SIPP then when you are 55 years old, you and your husband’s combined pot of savings would be worth £135,000 if the pot of money only grows fast enough to keep up with inflation of about 3%; if you get growth equivalent to the average stock market return of 7% then you would have £250,000 at the age of 55 and if you get an average stock market return of 10% you would have £410,000 saved up.
At age 60 the figures would be £180,000 @ 3%, £375,000 @ 7% and £700,000 @ 10%.
These sort of returns aren’t cuckoo. According thebalance.com, “the S&P 500 Index, delivered its worst twenty-year return of 6.4% a year over the twenty years ending in May 1979. The best twenty-year return of 18% a year occurred over the twenty years ending in March 2000.”
Various sources suggest the S&P 500 has returned 10% before inflation if you buy and hold the money you invest into it. But of course, it’s useful to remember that this past success doesn’t guarantee that future returns will be as good.
Right now you would struggle to find a bank account that gives you an interest rate of 1.5%.
Back to flexibility on when you retire, however, unless you believe the US has no room for growth, then this total of £250/month you are saving could amount to a lot of money over a 25 to 30 year period and this would allow you to retire with a decent income well before the state retirement age.
If your mortgage is fully paid off by the time you retire then your cost of living could be low enough that even a modest growth in the SIPP would provide a comfortable income before your state pensions and work-place pensions kick in.
The second reason: to save the money is the added security from having extra retirement income
Having money in a SIPP means you can top up your retirement income.
Having the SIPP would mean you have 5 sources of income:
If the pension income from your jobs is lower than your final salary having access to extra funds will mean you can more or less maintain your lifestyle. This will be especially important if one person lives a lot longer than the other.
There is one special feature that the SIPP has but all the other 4 pensions do not: and that’s the fact that if you or your husband dies the state pension stops coming through and the work-place pension either stops completely or is massively reduced. However, whatever money is outstanding in the SIPP would fully transfer to the spouse without penalty.
Just to be clear, I will make that point twice: a work-place pension either dies with the person and at that point the spouse receives nothing or, from that point, the spouse gets a heavily reduced benefit – usually 50% or one-third of the amount that was being received before their spouse died.
A LOT OF PEOPLE forget this about SIPPs and other defined contribution pensions. I won’t go into the differences between defined benefit and defined contribution pension plans here but if someone is interested go to themoneyspot.co.uk and leave me a voicemail with your request.
Finally, when can you expect to start spending that money and should you try to spend it in specific ways or on specific things?
Technically, the plan is that you will never have to spend the capital but can just spend the growth.
If the fund is worth £250,000 when you start drawing from it and you are earning a 10% return per year at that point, then you could just withdraw the 10% (i.e. £25,000) or less and spend that.
If your withdrawal rate is lower than the growth rate of the fund then your retirement would continue to grow even as you take money out.
Note that some research suggests that the ideal withdrawal rate to maximise the likelihood that the money will never run out is 4%. But given you have pension income from your jobs in addition to the state retirement and you’re not worried about passing wealth on to children you could be more aggressive than this.
As for how you spend that money, well that is up to you and is a great problem to have. Having more money doesn’t only mean more holidays, it also means you can buy private health insurance which might be a necessity to avoid NHS waiting lists at a time when health problems are more likely. This would give you a lot of peace of mind.
Ability to pay mortgage off early
One thing worth adding, is a note that once you can withdraw money from your SIPP you are allowed to take 25% out as a tax-free lump sum. If your household had £250,000 saved up, you could take £62,500 out in one go which could be used to clear all or most of your mortgage.
You would then be allowed to take the rest out as an income or you could buy an annuity – with an annuity you essentially buy a fixed income which keeps being paid to you for the rest of your life.
I wouldn’t recommend an annuity for you given you have two fixed pensions coming in already, you don’t need the extra security and annuities don’t tend to be worth the money now that interest rates are so low. What you could do instead of buying an annuity is withdraw what you need from the SIPP every year. You would pay taxes based only on what you take out and could manage the withdrawals to minimise the tax bill.
I hope this helps.
Have a money question?
Once you have decided on an investment strategy for yourself or for your children you need to decide where to invest and what to invest in.
WHICH PLATFORM TO USE FOR INVESTING
Choose a platform that has the lowest fees for the highest convenience. Fees change over time but when I was deciding on a platform I found these articles:
In the end, I chose iWeb for myself and Hargreaves Lansdown for the children’s investments.
I chose iWeb because annual fees are zero (after a £25 account opening fee) and you only pay £5 per transaction.
As I only transact once a month (on pay day), our annual household fees are £60 and if you consider that I only transact on either my account or my husband’s account in any given month, then we are only paying £30/year per account. More than fair.
The main problem with iWeb is that they don’t do junior ISA and you can’t automate investing. I don’t mind manually investing for my and my husband’s ISAs because we invest different amounts in different funds each month.
Why Hargreaves Lansdown?
They do junior ISAs, they have a good app and you can fully automate all your investing – their customer service is also pretty good; if you call you will get through to a human pretty quickly.
Ultimately, I don’t expect the children’s ISAs or pensions to have a value greater than £100,000 before they’re adults so a platform with a percentage fee will tend to be cheaper than one with a fixed fee.
When they’re older I’ll advise them to move to a cheaper platform.
Which platform will work best for you?
Unless you’re an investment buff that actually enjoys making monthly investment decisions, I recommend you choose a platform that allows automation, possibly Halifax share dealing or Cavendish; one of my friends recommends Fidelity.
For children, transact within a junior ISA. For yourself or partner, an adult ISA. If you can invest more than the annual limit then use the ISAs first before transacting via a taxable account.
WHAT SHOULD YOU INVEST IN?
Unless you have a lot of time to research different companies, I would only invest in low-cost (passive), well-diversified mutual funds such as an S&P500 tracker or a FTSE100 tracker. Passive means the fund is not actively managed, it just follows the stock market so your return is essentially the average market return.
Research suggests that actively managed funds (ones where a ‘clever’ manager stock picks) generally underperform the market in the long-run.
My long-run strategy is to have 70-80% of my money in (safe) passive funds and 20-30% in actively managed funds. ETFs? I don’t do ETFs – I think funds make more sense.
Over to you.
Have a question?
If you have any personal finance questions send them to [ME] – I will answer whatever piques my fancy via a blog post.
I just had my first baby. I'm 31 and married. Do you have any tips for how I can think about saving and investing for my baby?
This is an awesome time to be asking me this question. I also started planning for my first baby as soon as he was born.
You will be at an advantage if you start saving and investing for your children as soon as they are born. You will need to balance what you can afford with what you want to achieve for them. Firstly, what’s the goal? What are you saving for?
University costs c.£60,000 in tuition and living costs for a 3 year course at the moment - £10,000 for tuition and books, £10,000 for living – living costs can be higher or lower depending on whether you live at home, etc..
£60,000 is a huge amount of money and this cost is likely to rise in the future but it makes the maths too complicated to think about possible cost increases.
Option 1 for university savings
If you can save £20,000 in a tax-free account like a stocks and shares ISA by the time your child is 5 years old, then you can stop putting money aside and this money will have a reasonable chance of growing to £60,000 by the time your child is 18 years old.
How could you save this £4,000 per year? Perhaps you could target saving a round amount like £250 per month (equivalent to just over £30/week each for a two-income family) and because this sums to £3,000 a year, at the end of the financial year you’d hustle to throw that extra £1,000 into the ISA before the financial year closes on 5 April. Or, if you can afford it, you could just save £335/month and you would save just over £4,000/year.
Option 2 for university savings
£4,000 is likely more than most can afford. The alternative is to save £100/month until age 18 which most people can afford even on the median household disposable income of £29,400 (2019). It’s equivalent to about £12.50/week each for a two-income family).
Which option is better?
I would say option 1 trumps option 2 because you give the money the best chance of growing. Equity markets are volatile in the short-run so by saving the money early you give the money a better chance of reaching your goal. That said, something is a lot better than nothing: small savings add up to large amounts over time. Your savings may be lower than you would like to target but you will still help your children avoid the full scourge of student debt.
These are the results under each option:
Caveats on saving through a Junior ISA:
When you save the money through a Junior ISA, that money will be theirs when they hit 18 and you might not be able to control how they spend it.
However, putting it into the Junior ISA means you won’t be tempted to spend it yourself because once the money goes in, it can’t be withdrawn until your child is 18.
How can you avoid the Junior ISA so you have more control over the money?
Plan b. is a good option because you could end up not having to pay tax anyway:
The capital gains tax allowance in 2019-20 is £12,000. That is, you have to make a capital gain (the profit on your investment) bigger than this to pay the tax. If you save the £4,000 across two investment accounts - £2,000 in an investment account with your name and £2,000 in an investment account with your spouse’s name then when your child is 18 you can sell enough stock each year to keep the capital gain below the capital gains tax allowance.
The risk however is that this threshold could fall or be completely removed in which case you would end up paying more capital gains tax on the sale. It’s still a sensible option, despite this risk.
If you followed option 1 for university savings, at age 5 you’ll have stopped doing that and might find that you have some spare money to open a retirement account.
Your children will not have access to this money until they are 57 to 60 but if life hasn’t worked this will be a great cushion for them.
The beauty of investing in a retirement account is that for every £1 you put in the government puts in an extra 100/80. That is, if you want to save £100/month you only need to put £80 into the account. If you do invest £100 it will be £125/month with the government top up. For kids you can put a maximum of £2,880/year (£240/month) which equals £3,600/year.
This is the result if you choose to save £100/month indefinitely into your child’s Self-Invested Pension Plan or SIPP starting from when they are 5-years old:
You notice that the extra £25 from the government makes a real difference. By saving through the pension, based on a 7% return, on 7-Jan-2025 the investments are worth £9,269 rather than only £7,444 without the government top-up.
Don’t save into a child’s retirement account unless you have the cash flow and are meeting your own goals, e.g. paying enough into your own retirement, paying off your mortgage early and ideally, are debt free yourself (apart from the mortgage).
Some will be able to afford the full £240/month from birth, the rest of us have to work out what is realistic, that is why I personally opted for the £100/month from age 5. This decision will change with a change in your fortunes.
3. HELPING YOUR KIDS BUY A HOME
This is where the decisions get a little tricky. Some people will be able to afford funding university, helping their children get ahead with retirement savings and help with a deposit on a home without compromising their lifestyle at all but the rest of us need to make choices.
Private school vs. saving for a home
What will make the biggest difference to your children: a private education or getting onto the property ladder?
If you can afford one or the other but not both, then you might follow the route of private primary school followed by state secondary school (grammar/comprehensive). In this case you’d direct all the money you would have spent on a private secondary school education on saving for a home. In some cases this might mean your child starts life with a mortgage free home.
If you save £15,000/year (£1,250/month) from age 11 until age 21 (10 years of saving) and it grows at an average rate of 7%, how much money would your child have at 21? About £220,00 – increasing to £260,000 if the average return over that period is 10%.
This is not small money to most of us.
You could use every last cent on a private education when at the end of the day the thing that helps your child follow a life of fulfilment is being relatively debt free.
If you decide to go for a state education throughout and save £1,000/month (£12,000/year) from age 5 (when you are done with university saving) until age 21 (16 years of saving) and it grows at an average rate of 7%, how much money would your child have at 21? About £355,000 – increasing to £475,000 if the average return over that period is 10%, wow. Forget the children, you could be doing this for yourself!
If you have already made the decision to send your children to a private primary school and they are thriving, you are unlikely to reverse that decision. If I you are seeing these numbers before making a decision, you might well make a very different decision…
Not thinking about private education, anyway?
If private school is not a consideration for you, then the best choice might be to save as much as you can towards your own ISA allowance of £20,000/year (£40,000/year in a two parent home), in addition to whatever you save towards your pension (I recommend 10-15%) and when the time comes you can decide whether you can contribute towards university or a first home or both.
The best gift you can give your kids is possibly to be independent in old age so they don’t have to worry about taking care of you. You can boot strap them onto the property ladder by letting them live at home rent free – so that they can save more for their deposit. Even without cash gifts, you will be giving your children a competitive advantage by teaching them how to handle money at an early age.
Starting to invest
Next, you need to consider what platform to use for investing and what to investing in?
If you have any personal finance questions send them to [ME] – I will answer whatever piques my fancy via a blog post.
This article looks into what retirement & pensions look like for the USA and for black people in particular. Skip half way down if you just want the race-based statistics but not the overall picture.
Jim Crow laws and US-style racial segregation mean black people in America as a whole are still catching up with wealth accumulation.
This article brings together data and charts from various sources; references to all sources are listed at the bottom.
Overall, retirement statistics show a dim picture for everyone except the very affluent in America and the situation is worse for black and hispanic populations.
One factor that fascinates me is that the US doesn't have a national state pension system. This means old people have to claim social security benefits to get by.
This is important because in the UK and other developed economies you get the state pension based on your tax contribution history, it's essentially a prize for working hard during your life and whether you've got millions in the bank or not, you're entitled. You can even claim your state pension if you are still working when you reach retirement age.
In the US, you have to claim social security in old age in the same way you would if you were unemployed. There is no State reward for having been a long-standing tax payer when you reach retirement age in the US.
RETIREMENT STATISTICS FOR THE US OVERALL
Whilst the graphic below shows that the US is one of the best places for social connections and mental well being in old age, it is the third worst country in the list for old age poverty.
Only Australia and Japan are worse, even India a country far behind the US in development has better relative poverty in old age.
What proportion of an old person's income does this form?
RETIREMENT AND WEALTH FOR AFRICAN AMERICANS
"In 1983, the median white family had more than $100,000 in wealth, compared to less than $13,000 for African-American families—an eight-fold difference." (newrepublic.com) By 2013, 30 years later whites were 34% wealthier with $134k whilst black people were poorer with only $11k in wealth.
Hispanics were in exactly the same situation as the graph on the right shows.
Wealth by Race
White Americans earn a lot more, on average, than black Americans such that by age 61 the average white person had earned $2 million over their life and the average black person $1.5 million, Hispanics were worse off with $1 million in earnings by age 61.
Obviously, the more you earn the more you can save, earn interest and invest.
Liquid Retirement Savings
Liquid retirement savings are cash saved for retirement e.g. as a 401k.
In 2013, the average white family had $130k in liquid retirement savings, for blacks this was $19k and only $13k for hispanics.
BUT - the situation is actually worse than that, a few very rich people skew up the average number especially for whites. If you use the median, i.e. the middle person, whites only have $5k in retirement savings, blacks and Hispanics have zero.
Homeownership is one of the key ways people around the world build wealth.
The homeownership rate amongst black Americans (43%) is 60% lower than amongst whites (69%). For a very long time black Americans were locked out of property ownership because of discriminatory laws and even now, property prices are lower in black areas than in white areas and price growth is slower (Forbes).
Debts reduce people's ability to save.
Black Americans have higher levels of student debt, 42%, compared to 28% for whites and 16% for Hispanics. Ultimately this would be a good thing if it was leading to higher future incomes but black people also have lower graduation rates.
This means some people get saddled with debt and don't get a degree at the end of it to boost future income.
The lower student debt amongst whites could be because more of them have parental support in paying for tuition and living costs.
Keep in mind as you read the above that not all minorities are reflected in the statistics. The Jewish community and Asians tend to have better rates of saving, wealth accumulation and lower overall poverty than whites, blacks and Hispanics.
Closing the gap in property ownership will definitely be one of the key ways black people in America will boost the retirement asset base and wealth in general. Please take a look at my property toolkit for information on how to grow a portfolio.
You might also like:
Old Age Life, Pensions And Poverty In The UK
Which are the best countries in the world to grow old in? (The Guardian)
How Home Ownership Keeps Blacks Poorer Than Whites (Forbes)
The Alarming Retirement Crisis Facing Minorities in America (newrepublic.com)
Why you may retire in poverty (reuters)
Lots of scary statistics get thrown around regarding the negative retirement prospects for current 30-somethings (and even worse for those younger than us), so this week I’ve decided to dig deep. I’ll write a series of 3 articles on retirement: what do that the stats look like in the UK and the US and ultimately, what will it cost you to retire?
I will not do an article on retirement stats in Africa because for the most part those statistics are VERY hard to come by. However, I found a fantastical article by the OECD that looks at Pensions In Africa.
This is what I assume we all want to know:
When Do You Get A UK State Pension?
The retirement age used to be 60 for men and 65 for women. It’s now been equalized to 65 for both. It’s moving up to 66 by 2020, 67 by 2028 and 68 by 2046.
I’ll qualify to get a UK state pension at the age 68 in 2051 provided I’ve paid national insurance (NI) taxes or have NI Credits. You can calculate your own pension age here.
What does this mean?
Those of us that reach retirement age after 6 April 2010 need to have 30 “qualifying years” to get the maximum state pension and at least 10 qualifying years to get anything at all.
If you don’t have a National Insurance record before 6 April 2016 you’ll need 35 qualifying years. Qualifying years are years in which:
For instance, if you work abroad or aren’t working for any reason you can pay voluntary contributions to ensure you qualify for a full state pension. I see this as a sort of backup insurance policy and I would definitely do it if I was working abroad.
“If you reached the pension age before April 2010, then a woman normally needed 39 qualifying years, and a man needed 44 qualifying years during a regular working life to get the full state pension.” BBC
What’s The Amount of The UK State Pension?
If you are retiring on or after 6 April 2016 the full state pension you can get is £155.65/week, this is £8,094/year or £675/month.
This amount is guaranteed by the government to rise by the higher of:
But, of course, government plans do change and this guarantee could fall away if the UK hits problems. There is a lot of press surrounding this possibility right now.
How Much Does The Average Pensioner Actually Have In The UK?
People retiring in 2016 expected income of £17,700 per annum according to a Prudential survey. They carry out this survey annually and the table below shows the results.
This number is actually £1,000 lower than in 2008 but it’s been making a steady recovery:
What Do The Pension Savings of Workers In The UK Look Like?
According to Partnership the average UK pension pot stood at £87,724 in 2015. There is a lot of variance within the UK, with Essex having the highest pension pots, £125,478, and Shropshire the lowest, £44,336. Check out where your region stands using the image below.
With compulsory workplace pensions now in effect pension savings should hopefully rise for a good majority of people.
What Proportion Of Pensioners Own Their Home Outright?
Property ownership is one of the key determinants of financial independence in old age.
Here are stats from the 2011 census carried out by the Office of National Statistics:
The obvious advantage of outright home ownership when you are retired is that you save yourself what is usually a household’s biggest expense.
Home ownership is almost necessary to guarantee a comfortable retirement because state pensions rules are changing all the time.
Personally, I hope for the best when it comes to state pensions but I certainly won’t depend on the government to look after me in old age.
Have a business or life question you want me to answer? Please email it to me with the subject “Question”. Note that all such questions will be answered as a blog post and will be sent to my full email list.
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Basic State Pension Overview (gov.uk)
State Pension Eligibility (gov.uk)
State pension: The overhaul and you
The pension pot map of the UK revealed
Retirees in 2016 expect income of nearly £18k a year
Home ownership and renting in England and Wales
Number of UK working-age households drops for first time
Pensions In Africa
Heather on Wealth
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