How much is enough to retire on?
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These are the days of personal pension responsibility. As more and more of us rely on defined contribution pensions when we stop work, we’re exhorted to “engage” with our retirement pot through our working lives — maximising contributions, considering how the money is invested and lovingly watching it accumulate.
Yet it’s all too easy to feel you’re saving into a void. You might know what your pension pot is worth now, but how much income could your capital provide in retirement? And, crucially, how much annual income will you need to be comfortable and fulfilled when you stop working?
Of course, everyone’s expectations for retirement are personal: someone who dreams of escape to a highland croft to tramp the hills will have a different budgetary sweet spot from her cruise-crazy colleague. But there’s a need for generic, broad brush guidance as to how far different levels of post-work income will stretch.
Research by the Pension and Lifetime Savings Association (PLSA) in 2018 highlighted the extent to which people feel themselves in the dark in this respect, finding that 77 per cent of savers don’t know how much they will need in retirement.
To bridge that knowledge gap, the PLSA created its retirement living standards (RLS). These are based on the cost of a range of common goods and services, and aim to show what life in retirement would look like at three different income levels.
Nigel Peaple, PLSA director of policy, explains: “The PLSA hopes the standards will one day become a rule of thumb for retirement planning.” So far they have been adopted by over 50 organisations, including 30 pension schemes.
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The “minimum” RLS covers essential needs “plus enough for some fun”, according to Mr Peaple. That might include an annual UK holiday, eating out once a month and “affordable leisure activities” a couple of times a week.
“Moderate” provides greater financial security and more opportunities, while “comfortable” caters for “some luxuries like regular beauty treatments, theatre trips and three weeks in Europe a year”.
Assuming no mortgage, rent or social care costs, the PLSA suggests a single person needs roughly £10,000 a year to achieve the minimum RLS. They will need £20,000 for the moderate level, and £30,000 for the comfortable one. For couples, the respective figures are £15,000, £30,000 and £45,000. The tables below show the precise values.
Clearly these income levels won’t cater for everyone’s aspirations, but they provide useful baselines against which to assess your own lifestyle. The question then is how to reach or exceed those income benchmarks.
The PLSA tables below build in the state pension, the required level of income from a defined contribution (DC) pension and the pot size needed to generate it from an annuity, but they don’t take account of other assets — savings, Isas or final salary pensions, for instance.
Sir Steve Webb, a partner at pensions consultancy LCP, sees value in the PLSA benchmarks as “a helpful order of magnitude”. However, he stresses that “what you need in retirement really depends on what you’ve been used to and what your outgoings are.”
He suggests a simple rule of thumb to assess what kind of income you can expect from your pension pot. Level annuity rates (a fixed sum payout not linked to inflation) currently sit at about 5 per cent. Therefore, Sir Steve suggests every £1,000 worth of pension fund will provide about £50 worth of income a year. So a £500,000 pension pot could buy a guaranteed annual income for life of roughly £25,000.
However, the fact is that few people these days actually buy an annuity with their pension pot, certainly in early retirement. Instead, most choose to leave it invested and draw down an income, which provides more flexibility but entails much more uncertainty.
“There are many factors that need to be considered [in this scenario], including growth, charges, and market corrections, before you can even have an idea what the fund would be worth, let alone what income it could provide,” cautions Claire Trott, head of pensions strategy at financial adviser SJP.
At the same time, it’s very useful to have a clear idea of your own personal likely outgoings in retirement. The RLS figures provide a generic starting point, but as Ms Trott notes: “Advisers are often needed to guide their clients to understand what their outgoings are likely to be in retirement, delving deeper than clients would usually do on their own by asking difficult questions.” Those might cover the situation regarding dependants, outstanding mortgages and plans for retirement, as well as regular outgoings.
Using that information and building in assumptions about a client’s various investments and future financial sources (for example the state pension, and any inheritances), financial planners can employ “cash flow modelling” to predict how that client’s finances will work out.
Nick Onslow, a financial planner with RU Group, puts it succinctly: “The cash flow is like a timeline that looks at what you have now and what you may get in the future. It builds a picture in graph form. The aim is to ensure you save enough money to meet all your objectives and never run out.”
But a good plan is a complex construction. This is one point in life where professional input really should pay dividends in terms of financial clarity and reassurance.
Faith Glasgow is a freelance journalist and the former editor of Money Observer. Twitter: @faithglasgow