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How much you need to save for retirement
I'm going to give you one method for estimating how much you, personally, need to be putting aside for a comfortable retirement.
You'll need to set aside a fair bit of time to do this, so bookmark this page for later if necessary.
Step one - calculate your outgoings
Many costs, such as raising children and paying the mortgage, should be long paid for when you go into retirement. Other costs, such as greater heating and water bills, and buying more newspapers, might go up.
Some retired people need a fraction of what they needed when they were younger and others, particularly if they decide to travel a lot, need more.
Use this quick budgeting tool to help you estimate what your outgoings will be when you're retired. Just enter all the amounts in today's prices, forgetting about inflation for now.
Don't worry that you might get it wrong or that your needs and wishes will change by the time retirement arrives. We'll deal with that problem by the end of this guide.
Make a note of the total and keep the detailed breakdown of all your expected outgoings.
Step two - income tax
Another outgoing you'll probably have is income tax. This isn't in the budgeting tool.
Use this income tax calculator to get a rough idea how much tax you'll pay in retirement. I warn you, this can be a bit fiddly, but there's probably no point being too precise at this early stage.
To use the calculator:
ignore the year column,
change the age field to your desired retirement age range,
type in your annual outgoings, plus £1,000 extra and
press Calculate.
The results will show a yearly “net wage”. If that is roughly the same as your outgoings from step one, you can proceed on the assumption you'll pay around £1,000 in income tax.
If the net wage is wide of the mark, you'll have to press Back on your browser and use trial-and-error to get the net wage closer to the outgoings you estimated in step one.
Once you're reasonably happy with your estimate of taxes, add that to your outgoings in step one. You should now have total expected outgoings including taxes.
Step three - state pension
Estimate your future state pension income using this state pension calculator. The calculator will show your pension on a weekly basis, so multiply the answer by 52 for your annual pension.
If you're not confident the Government will be as generous by the time you retire, you could play safe by halving that estimate.
Write down your estimate.
Step four - calculate value of work pension schemes
You might have a final-salary or career-average pension scheme through your employer and others from previous employers. These are also called defined-benefit pensions.
Ask the pension scheme administrators for benefits statements, so that you can get a projection of the retirement income you'll get from your pensions.
If you don't know what pensions you've got, or can't find them, use the Pension Tracing Service.
Add up the estimates of your future retirement income from all the pension schemes.
Step five - your retirement income
Add together:
the state pension estimate from step three and
the annual pension estimate from step four.
If this total amount is higher than your expected outgoings from step two (which includes your estimate of taxes), it looks like you're on course for a comfortable retirement.
[SPOTLIGHT]Don't forget that this is just a projection with lots of assumptions.
Step six - your retirement balance
Deduct the total in step five with your total from step two. Write this figure down.
Step seven - your own pension saving
Now we turn to your existing savings and investments for retirement, which might include share ISAs, personal pensions, stakeholder pensions, SIPPs, and defined-contribution or money-purchase pensions from your employer.
Get the most recent annual statements from all these pots, or contact the provider to find out the size of your funds.
Add all the pots together.
Step eight - how much do you need?
Use Hargreaves Lansdown's annuity table, or similar tables, to estimate what pot you'll need to save.
The table currently show a 65-year-old needs a £100,000 pot to get an annuity income of £6,000per annum, paid every year for life.
If you don't already know what type of annuity you want, I suggest for this exercise that you use the “single-life, level, no guarantee annuity” if you're single. If you're married, you could use the “joint life 50%, level, no guarantee annuity”.
Here's an example to explain what to do next. Let's say that your shortfall in step six was £5,000 per year. Let's also say your annuity rate in the Hargreaves Lansdown annuity table is £5,400 per £100,000 (such as it is for a single person who wants to retire at 60).
Now you do this sum on a calculator:
type in the figure from step six: 5000 in our example,
divide this by the annuity rate: 5400 in our example, and
multiply by 100,000.
In my example, the answer is 92592.593, which means you'll need to grow a pot of £92,592.59 to reach your comfortable retirement.
Step nine - reaching the right retirement pot
The moment of truth. Use this compound interest calculator to estimate how much you need to save each month to reach your needed retirement pot. To use the calculator:
type in your answer from step eight,
type in how many years you've got before you want to retire,
type in your answer from step seven
type in an estimated annual return, for which I suggest you type 2.5 (More on that shortly.)
The calculator should now tell you how much you need to save.
Just for example, if you need to grow a pot of £92,600, already have £20,000 in personal pensions and share ISAs, and you've got 30 years before you want to retire, your answer in the calculator should be that you need to save £95 per month.
Hang on. Why use “2.5”?
For your annual gains, I have suggested you estimate around 2.5% per year. That might seem small, but this is how much your investments might grow over-and-above inflation, and 2.5% would actually be a fine rate of return.
If inflation averages 4%, say, with your 2.5% on top you'd be getting 6.5% per year in total, which is a lot more than you should expect from savings accounts.
A 2.5% return over 30 years will double your money in real terms, meaning that despite inflation you'll be able to buy twice as much with your savings.
You'll have to keep your saving and investing costs down if you want a reasonable chance of getting 2.5% or more above inflation. Do your research to find out how you could go about that. You could start by reading Why most pension savers lose and How to get higher investment returns with lower risk.
Step ten - Government contributions
The Government will pay you part of your pension contributions if you're paying into a pension. This means that, in my example from step nine, you wouldn't have to pay in £95 per month.
If you're a basic-rate taxpayer using a pension to save type the answer to step nine into a calculator, which is 95 in my example and multiply by 0.8
The answer in my example is £76, and that's how much you should save per month.
Higher-rate taxpayer can also currently claim back even more through your tax returns, which would rebate you another £19 per month in my example.
Step eleven - a safety net
I strongly suggest you add in a safety margin. If you can afford to pay an extra £25, £50 or £100 per month, that gives you some more assurance.
Revisit step one again
What you expect you'll need in retirement will change over time, and your savings and investments won't perform as you forecast. The income you might get at the end can also change.
That's why you'll have to repeat this exercise once per year to ensure you're on track. Do this every year and I think you should be able to stay on track with just minor adjustments, and few major shocks and surprises.
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