How Much Do I Need to Save to Retire at 55?
There’s an old joke: ‘Jumping from a plane is easy; the hard part is hitting the ground.’ Similarly, choosing to stop work is something you can do at any age; what’s difficult is supporting yourself after that.
Pension freedom means that anyone with a pension pot can access it however they wish from the age of 55. However, ‘can’ does not mean ‘should’. It’s usually good practice to preserve your pension pot for as long as possible, since this will be your main income in retirement. For most people, therefore, retirement will usually come in their mid-60s.
But suppose you did want to enjoy a long and youthful retirement by finishing work at 55? How much would you need to save, and how achievable is it? Here are some of the things you would need to think about.
Retirement planning: start with what you know
Although you can’t predict the future, there are some things you can estimate now with reasonable certainty. Start by asking yourself the following questions:
1. How much income will I need in retirement?
A popular way to estimate this figure is the ’70% rule’, which states that a person in retirement will need 70% of their working income to maintain the lifestyle they want. So if you retire on a salary of £50,000 you would be looking at achieving an income of around £35,000.
For some people, 70% may be generous and they would be comfortable living on less. Conversely, others may struggle.
2. How might my income needs change over time?
This is another key point to consider. Early in your retirement, you may want to spend more, enjoying your freedom, travelling and treating yourself. Later on, you may settle down and begin to spend less – but later still there may be a need for expensive long-term care. These changing requirements may influence how you decide to take your pension.
3. Will I have other sources of income?
Your pension may not be your only source of funds. Other assets such as savings, investments or properties can be used to help fund your retirement, or you could work part-time, start your own business or even just rent out a room in your home. Factor these into your overall annual income.
You should also eventually begin to receive the state pension, assuming you qualify for it. State pension age is currently 65 for most people and is expected to be 68 by 2044. Currently, the full state pension pays around £8,500 per year, so you can factor this into your long-term plan (i.e. you may not need to take as much from your private pension once you start to receive the state pension).
Now think about what you don’t know
Certainty is impossible in retirement planning, but you can identify the blind spots in your knowledge and plan around them. Your plan will need to account for the following unknowns:
1. How much will prices rise over time?
In other words, what will inflation do to the real value of your pension pot? In some ways, this is one of the ‘known’ factors, as inflation of some sort is virtually inevitable. In the past 25 years, purchasing power has almost halved – meaning that £1 in 2018 can buy only as much as 50 pence could in 1993. Retiring at 55 might easily result in a retirement of 25 years, or considerably longer, so you’d need to factor in how much your spending power would reduce in that time (and also, of course, between now and the day you retire).
2. What will annuity rates be when I retire?
You may decide to buy an annuity (a guaranteed income for life) either when you retire or at some later date. Annuity rates are poor at present, but may change in future. You may also be able to get an enhanced (more generous) annuity if your health deteriorates later on.
3. How long will I live?
These days, living to the age of 90 and over is not uncommon. If you retire at 55, that would mean a 35-year retirement. Would your pension pot be enough to sustain you over that time? Also the inflation issue (see above) becomes even more pressing – prices in 2018 are triple those in 1983.
4. How will the stock market perform?
If you keep your pension pot invested and make regular withdrawals (i.e. you have a drawdown scheme), its value will go up and down with the stock market. Over time the market generally increases in value, but there are inevitably periods of loss, and sometimes big crashes. Withdrawing money during one of these dips can erode your pot’s value much more quickly.
Working out what you need to save
To see how all these questions work in practice, let’s consider Craig. He earns £60,000 a year and would like to maintain a similar lifestyle after retiring at 55. Using the 70% rule, he estimates he needs an income of £40,000 a year in retirement.
Craig estimates that he’ll live to the age of 80, meaning a 25-year retirement. He also assumes average growth of 4% interest on his pot (which is reasonable, but not guaranteed). If he were to draw out £40,000 per year, he would need £650,000 in the pot initially in order for it to last the full 25 years (it would actually last just over 26, but Craig likes to leave a margin of error).
This calculation doesn’t take into account Craig’s state pension, which he would start to receive 10 years after he retires, but he decides not to include this in his estimates in case he lives a lot longer than he expected.
So if Craig discounts the state pension from his figures, he’ll need to save that pot of £650,000 by the time he’s 55. Can it be done?
How to save up £650,000
If Craig saves from the age of 25 until he’s 55, he has 30 years to build up his pot of £650,000. Again assuming a growth rate of 4% (not guaranteed!), a monthly deposit of £925 would build up a pot of nearly that much (£644,136) thanks to compound interest. Assuming basic-rate tax relief of 20% (though Craig will qualify for double that on some of his earnings during periods when he pays higher-rate tax) this requires a monthly contribution of £740.
Let’s further assume that Craig has a good employer who matches every pension contribution he makes. Now Craig himself only has to pay in £370 every month. As Craig earns £60,000 a year (£5,000 a month), that works out as between seven and 8% of his income – which sounds perfectly doable.
Of course, it isn’t quite as simple as that, as Craig is unlikely to be on £60,000 all of his life. Assuming he might earn £25,000 at the age of 25, that £370 a month would be a whopping 18% of his salary – far more than most people could afford.
If you are interested in having a conversation about some of the benefits of having a proper financial plan then please don’t hesitate to get in touch.
This article first appeared on Unbiased.