These days one can expect to spend anything up to 30 years in retirement, and that's assuming you work until your seventh decade. And while many may have wistful ideas of the gardening, travelling and other hobbies they'll undertake on departing the rat race, all too many have yet to set in motion a concrete plan for ensuring these luxuries will be financially feasible.
Joining up the dots between your current savings rate and your desired future lifestyle is a difficult process and one that will benefit from the educated eye of a financial adviser. Should you feel that you're not in a position to enlist that help, here are some pointers to help you get your retirement plan on the straight and narrow.
What Does Retirement Look Like?
Your situation and your dreams may well change but it's important to have an idea of what it is you're aiming for. Does your imagined retirement involve a quieter life or a more active life than you currently need? Do you see yourself endlessly exploring the world or quietly turning your garden into the model of self-sufficiency? Does retirement mean turning your back on work or will it present an opportunity to develop a business idea you've previously lacked the time to focus on? Only you can answer these questions and though your answers may change over time, the aim is to attach a broad price tag to your dreams.
If, for argument's sake, you will own your house outright by the time your retire, you expect to continue bringing in an income via part-time activities, and you plan on spending your new-found freedom visiting family in the UK, growing your own veg and occasionally holidaying abroad, you might decide that a pension pot that will pay you £20,000 a year is sufficient.
Alternatively, should you be planning on catching up on missed opportunities—travelling the world, learning new languages and skills, experiencing daredevil activities, eating and drinking in luxurious establishments, and spending each Christmas with family in Australia—you may find that an annual income of £50,000 from your pension barely scratches the surface.
Health plays a crucial role in this process. Do you descend from a long line of centenarians or have many of your descendants died before they got into the full swing of retirement? Does long-term illness run in the family and if so, how do you plan to deal with it—NHS treatment or private healthcare, family-dependent or specialist retirement home? It's not morbid to think this way, it's essential.
Last but by no means least, what do you wish to leave behind? Are you happy for your children to make their own way or do you want to leave them with a hefty inheritance? These are just some of the questions you need to ask yourself when constructing a plan to cater for your retirement.
How Much Do You Need?
A now debunked myth stated that you should aim to have invested enough to receive an in-retirement salary that equated to 80% of your in-employment salary. Many will find that just 40% of your final salary will see you through potentially three decades of retirement. Your lifestyle, length of life and quality of life will dictate the figure that suits you.
Let's say, for argument's sake, that you are currently 40 years of age and you earn an annual salary of £70,000. You plan to retire at 70, and your idea of retirement involves the simple life with an added annual injection of excitement in the form of international travel. You will no longer be paying off your mortgage in retirement, so monthly outgoings will be vastly reduced, though your annual travel splash will likely cost up to £5,000. Your health is good and your family members have a habit of living well into their 80s.
A back-of-the-envelope calculation might suggest that you could comfortably live on around 50% of your current salary in retirement—£35,000 per year. You reasonably expect to live another 20 years after retiring and you plan on taking out long-term healthcare insurance. Another rough calculation on that envelope might imply that a pension pot of £700,000 would see you through; and, if you invest in a way that you can live off a combination of withdrawals and interest, your family might also receive some additional wealth on your death.
This guestimate might surprise some. It is, after all, a pension pot that is almost enough to make you a millionaire. But reaching this goal needn't be as arduous as you might think.
Sticking with our hypothetical case, an annual investment of just 10% of your current salary (i.e. £7,000) invested in a moderate-risk portfolio (say, 65% equities, 35% bonds) over a period of 30 years (until retirement at age 70) has a fair probability of nearing that £700,000 goal.* That means saving £580 a month and reinvesting any dividends. That shouldn't be too hard a task for someone earning £70,000, particularly when you think about what the reward is: the comfortable retirement that you've dreamed of.
*These are approximate values based on a hypothetical case study. Morningstar's Asset Allocator tool can help you identify the probability of hitting your financial goals.
How Can You Get There?
There are numerous tools to help you invest your way to a comfortable pension. Pensions and ISAs are the most popular and these come with tax benefits too. Of course there's the State Pension as well, but who knows if that will still be around when you’re approaching retirement? Better to cater for the worst-case scenario and make your own arrangements.
One of the rules of investing for retirement is to start early. The magic of compound interest means that your retirement pension pot is more than just the sum of your instalments: the cumulative effect ensures that the more years of interest you accrue, the greater your overall returns.
Individual Savings Accounts (ISAs) allow you to invest in stocks and shares without incurring income tax on your returns. Meanwhile, the great benefit of a pension scheme is that the government gives you tax relief. Want to save £100 per month in your pension? Put in just £80 and the State will top that up with another £20 (20% income tax relief), totalling £100. Better still, if your company offers to also contribute to your workplace pension, that's an offer of free money that you shouldn't refuse.
Here's a working example: let's go back to our imaginary friend who's 40 years of age and earns £70,000. Let's assume his employer will match his pension contributions up to 5% of his salary. That means that if our friend wants to make the most of this offer, he also needs to contribute 5% to his company pension. That’s £3,500 per year, which amounts to just over £291 per month. If he contributes £291 a month, State tax relief will top that up by another £73 to total £364 per month. Add onto that his employer's matched contribution of another £291 and our friend has socked away £655. Not only has he comfortably beaten his own goal of saving £580 per month but he's done so at only a cost of £291 to himself.
Our hypothetical scenario has our friend saving a total of just over 11% of his salary on an annual basis in a stocks and shares pension, with a 30-year time horizon and a goal of £700,000 by the time he retires at 70. All things being equal, our calculations have suggested that a little under £300 per month should put our friend on the road to success.
Conventional wisdom states that 10%-15% of your salary is a reasonable annual savings target when investing for retirement. But time really is of the essence: if our friend delayed saving into his pension by just five years, the chances of hitting that £700,000 are drastically reduced and he'd need to adjust his idea of retirement.
This has been a very brief overview. For more information on pensions, see An Introduction to Pensions and be sure to read the related articles.
Use Morningstar's Asset Allocator tool for an idea of how much to put aside, and Morningstar's Portfolio Manager and X-Ray tools to manage your portfolio.
A version of this article was originally published in November 2012.
