It's surprising how little you need to save to retire … if you start early!

The Money Spot™ - UK Personal Finance · #49 You won’t believe how little you need to save to retire … if you start early!

You can listen to this episode on YouTube.

Retirement is a dream shared by many of us, but achieving it requires careful planning and early action. In this article, we’ll delve into the world of retirement savings and reveal exactly how much you need to save each month to retire comfortably. So, if you're aiming for financial independence but are possibly thinking it’s a pipe dream, buckle up and discover the key to retiring early!
 
Understanding the two pension types – DC and DB pensions
 
Before we jump into the numbers, let's familiarize ourselves with the two primary types of pensions: Nowadays, most people have "defined contribution" (or DC) pensions, where the amount you and your employer contribute determines your retirement income. The risk lies with you, because your return, i.e. the pot of cash you’ll have at retirement, depends on the performance of the stock market.
 
Previously, "defined benefit" (or DB) pensions were more common, guaranteeing a pension until death based on your final or average salary and the years of service. However, DB schemes have mostly been phased out and won’t be covered in this article.
 
If you have a DC pension, if the stock market performs poorly you’ll either have to work longer or plan for a leaner retirement. Defined contribution schemes are sometimes called ‘money purchase’ schemes or self-invested personal pensions (SIPPs). They are similar to what Americans call 401K plans.
 
How do you calculate your retirement "pot"?
 
To estimate the size of the retirement fund you'll need, we can employ a simple rule of thumb. Multiply your desired annual retirement income by 25, and voila! You have worked out roughly how much you should aim to accumulate. But why 25?
 
This is based on the ‘4% rule’ – a widely accepted guideline that suggests that withdrawing 4% of your invested pot annually, ensures your money lasts. Research has shown that even after three decades, your investments tend to grow due to average growth rates of a diversified investment fund surpassing the 4% withdrawal rate.
 
{If the nerd in you wants to get into the maths: 4% = 4/100 and 100/4 = 25; … you don’t need to understand the maths, though, just use the rule}
 
Estimating your retirement expenses – how much will you need to spend in retirement?
 
Now, let's discuss the various lifestyle options and corresponding expenses you might encounter during retirement: according to research conducted by Loughborough University and the Pensions and Lifetime Savings Association, we can categorise retirement lifestyles into three levels: minimum living standard, moderate lifestyle, and comfortable lifestyle. To account for inflation experienced since these studies were done, I’ve increased the figures by 20%.
 
To maintain a minimum living standard, a single retiree requires an annual income of £12,240, while a couple would need £18,840. For a moderate lifestyle, the figures rise to £24,240 for a single person and £34,920 for a couple. Lastly, to enjoy a comfortable retirement, aim for an income of £39,600 if you're single or £57,000 for a couple.

£	Single person	Couple
Minimum living standard	12,240	18,840
Moderate lifestyle	24,240	34,920
Comfortable lifestyle	39,600	57,000

(source: moneyfacts.co.uk; and increased by 20%)
 
What are these different lifestyles assuming?

​A minimum living standard assumes a single retiree spends £46 per week on a food shop, has a one-week holiday and a long weekend in the UK each year, does not own a car and spends £555 a year on clothing and footwear.
With a moderate lifestyle, our single retiree spends £55 on food each week, enjoys two weeks in Europe and a long weekend in the UK each year, and spends £900 on clothing and footwear each year.
With a comfortable lifestyle, the single retiree spends £67 per week on their food shop, enjoys three weeks in Europe every year and spends £1,200-£1,800 on clothing and footwear each year.
 
Calculating your investment targets
 
Using the 4% rule and these lifestyle figures, we can estimate the amount you need to save for retirement. Here's a breakdown based on your desired lifestyle and whether you're single or part of a couple:

£	​Single person	Couple
Minimum living standard	306,000	​471,000
Moderate lifestyle	​606,000	873,000
​Comfortable lifestyle	​990,000	1,425,000

I know that these numbers look huge. But keep listening, I’ll show you that you can achieve them much more easily than you think.
 
Getting started: how much to save each month
 
Now, let's explore the exciting part—how much you need to save each month to reach your retirement goals.
 
Assuming you're a basic rate taxpayer, investing in a global passive fund with an average annual growth rate of 7% (we’ll discuss whether this is a reasonable assumption in a future post), aiming for the ‘comfortable’ lifestyle (i.e. £990k if single; £1.425m for couples) and ignoring the state pension (I’ll explain why in the next article) and employer contributions these are the monthly amounts you need to put into a pension account based on your starting age (rounded to the nearest 5):

Each month until you’re 68 you need to save:

If you start saving by the age of:	Single person	Couple (each)
22 (save for 46 years)	£195	£140 (£280 total)
25 (save for 43 years)	£240	​£175 (£350 total)
35 (save for 33 years)	£510	​£370 (£740 total)
40 (save for 28 years)	£760	£545 (£1,090 total)
45 (save for 23 years)	£1,155	£830 (£1,660 total)
50 (save for 18 years)	£1,825	£1,315 (£2,630 total)
​55 (save for 13 years)	£3,100	£2,230 (£4,460 total)

What the table shows is that the younger you start saving and the longer you save for, the less you need to set aside each month.
 
Factors that can offset the numbers
 
Don't worry if these saving targets seem daunting because there are several factors that can actually work in your favour, offsetting even the larger amounts you need to save if you start late. Let's take a look at these positive factors:

• If you're employed (i.e. rather than self-employed), chances are your employer will also contribute to your pension fund, on top of your own contributions. Many employers even offer a ‘matching’ programme, where they match a percentage of your contributions. For example, if you contribute 3%, your employer will also contribute 3%. Contact your HR department to learn how your company’s policy works.
• The state pension can also help offset the amount you need to save. However, whether or not you should include the state pension in your basic calculation for your target pension pot is open to debate.
• Any gifts or inheritances super charge your journey to retirement. However, research suggests that the average Briton doesn’t get an inheritance until about the age of 61. If you’re very fortunate, you may receive a gift or inheritance from your grandparents – although at that stage you will more than likely need to invest it in a home, putting a portion into a pension would supercharge its growth. Here’s how the magic of compounding works:
  • Imagine receiving a £10,000 gift at the age of 28 and investing it in a diversified global passive equity fund. By the time you turn 68, without any additional contributions, that initial amount would grow to an impressive £163,000, assuming a 7% return. Similarly, if you had £50,000 at age 22 and let it grow with the same assumptions, it would multiply to an astonishing £1.2 million by the time you're 68.
• Lastly, if you're a 40% taxpayer, the tax savings on your pension contributions are even greater. Contributions to your pension are made before taxes are calculated, so saving becomes more efficient. This means you need to save even less to achieve the same effect as someone in the 20% tax bracket.

 
In conclusion, securing a comfortable retirement requires forward thinking. If you didn't have this information when you started working, don't worry—now you do! There's no time like the present to start saving for your future. And here's a bonus: you can share this valuable knowledge with your children, ensuring they don't make the same mistake that many others do—starting too late. With the right strategies and a proactive approach, you can pave the way for a financially secure and fulfilling retirement. Your future is in your hands.
 
References
What Is the 4% Rule for Withdrawals in Retirement and How Much Can You Spend?
Q&A: How much do I need to save for a comfortable retirement?
Pensioners need a £33,000 a year income to enjoy a comfortable retirement
Fidelity Retirement calculator
How to get the £260,000 pension pot needed for a comfortable retirement - and why it might not be as hard as it sounds
Dave Ramsey investment calculator (ignore the $sign)
Fidelity.co.uk retirement calculator
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