How much is enough to retire on?
As more and more of us rely on defined contribution (DC) pensions when we stop work, we are 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 is all too easy to feel you are 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?
In 2018, the Pension & Lifetime Savings Association (PLSA) carried out some research, finding that 77% of savers do not know how much they will need in retirement. This led them to create 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. The PLSA hopes the standards will one day become a rule of thumb for retirement planning.
The ‘minimum’ RLS covers essential needs plus enough for some fun, according to the research. This might include an annual 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.
A simple rule of thumb to assess what kind of income you can expect from your pension pot could be to look at what an annuity will provide. Currently, level annuity rates (not linked to inflation) sit just below 5%. Therefore, 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.
The RLS figures provide a generic starting point, but in most cases, advice is required in order to guide clients to understand what their outgoings are likely to be in retirement. As advisers, we tend to get clients to delve deeper than they would usually do on their own by asking probing and difficult questions. Our challenges might cover situations regarding dependants, outstanding debt (mortgages) and any specific plans for retirement, as well as regular outgoings.
Using all this relevant information and building in assumptions about a client’s various investments and future financial sources (for example, inheritances), we can employ cash flow modelling to help predict how a client’s finances will work out. 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 and the aim is to ensure a client saves enough money to meet all objectives and never run out of cash.
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. For more information, call Prosperis on 01423 223640 or email us below.
