Q&A: How much do I need to save for a comfortable retirement?

Hi Heather,
 
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

The Money Spot™ - UK Personal Finance · #13 How much do I need to save for a comfortable retirement?

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.
 
ANNUITY
 
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.
 
DRAWDOWN
 
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.
 
SPENDING
 
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:

• A minimum living standard assumes a single retiree spends £38 per week on a food shop, has a one week holiday and a long weekend in the UK each year, will not be able to afford a car and will have £460 per year for clothing and footwear.
• A single person able to afford a moderate retirement will be able to spend £46 on a food shop each week, enjoy two weeks in Europe and a long weekend in the UK each year, and will have £750 to spend on clothing and footwear each year.
• A single person enjoying a comfortable retirement will be able to spend £56 per week on their food shop, enjoy three weeks in Europe every year and spend £1,000-£1,500 on clothing and footwear each year.

 
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:

• You need £825,000 if you are single before accounting for state and other pension income; (33,000/4%=825,000).
• If you are getting £8,500/year in state pension income, this falls to £612,500 if you are single; ((33,000-8,500)/4%=612,500).
• A couple without any other pension income needs £1.2m in investment assets; ((47500)/4%=1,200,000)
• A couple with two state pensions that sum to £17,000 needs 762,500 in investment assets to achieve a comfortable retirement; ((47500-17000)/4%=762,500)

 
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:

• For the amount of investment assets you need before accounting for pension income, just divide the income you want by 4%, e.g. £30,000/4% = £750k.

 

• To account for pension and other income, subtract amount of state pension and other income you expect to get when you’re retired from your ideal retirement income then divide by 4% e.g. (£30,000-20,000)/4% = £250k.

 
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?

• For 4 weeks in the sun each winter, add £3,500;
• For another 2 weeks of holiday each year, add £1,600;
• For dining out with friends every two weeks, add £2,200;
• For home improvements each year, add £3,600 – this sounds like a lot to me but anyhow, this is what is suggested;
• For a new car every 5 years worth £16,500, add £5,500 – this could also get you a higher spec second hand car;
• For health club membership, add £500;
• For shopping trips, add £1,600;
• For theatre, concerts etc., add £1,700

 
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!
Heather

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