How Much Should I Be Saving for Retirement? A Practical Guide

Introduction

Saving for retirement is a topic that it can be particularly difficult to get excited about. It's one of those things that doesn't really feel like it's important, or relevant to you, until you actually need it. By then, of course, it's too late to do anything about it.

Everyone wants a comfortable retirement. We want to be able to know that after a lifetime of hard work, we can continue our current lifestyle.

Although the state pension pot that is on offer from the government contributes a little bit towards this, there's no way around it. We need to have retirement savings too. Which begs the question: How much should I be saving for retirement?

How Do I Know How Much to Save?

There are two ways of choosing how much you can save for retirement. The first is bottom-up. Work out how much of your income you are able to start saving for the short term, medium term and long term.

This means that by a process of elimination, you'll figure out how much you have left over after house savings, car savings, holiday savings etc, and can then forecast this forwards over the course of the rest of your career.

We don't recommend doing this.

The second is to work out what the cost of your current lifestyle is (after temporary costs like mortgage payments if you're expecting to pay this off). Once you've done this, you can work out how much you'll need to start saving and invest in order to provide this annual income in requirement.

This is a good rule for ensuring your financial security in retirement. Of course, it depends on individual circumstances but most people who don't life a lavish lifestyle will probably not be spending a crazy amount of money.

You should also think about things like life expectancy and discretionary spending - you want to make sure that although you're not living lavishly, you can spend enough to enjoy a comfortable retirement lifestyle.

Example

Let's look at a worked example. If you earn £50k now, your UK take home is £38k at the date of writing. If £18k of this goes to your mortgage, which will be paid off by retirement, and £5k to savings, you are currently living on £15k pa.

Let's say you want to continue this level of lifestyle in retirement.

With a paid off property and £15k of lifestyle costs per year, you will want to have a pension pot that supports this level of withdrawal per year. Let's ignore state pension for the time being.

You can either:

• Build up a personal pension pot that you can withdraw 15k/pa from for the estimated number of years you have left to live, and hope you don't hit 0
• Build up a personal pension pot that will spit off £15k+ in returns each year without drawing down on the principal. It is generally assumed that a diversified pot of investments can return 4% in perpetuity without going to 0. This is what's known as the safe withdrawal rate. So to set this up you'd need £15,000/4% = £375,000. This is the safe option.

Note that for the purposes of this example we have not taken into account tax relief or inflation, and assumed thereby that your asset growth will outpace future inflation. Which further highlights the need to build a bigger pot than you need.

Types of Pension

So what are the vehicles you might use to build up your retirement savings pot? You have your general investment and savings accounts, which you should hopefully be contributing to already. Beyond that, you will likely have at least one of the following types of pensions:

personal pension, workplace pension, sipp, guaranteed income, more financial security, retirement goals,

Workplace Pension

As the name suggests, a workplace pension is a pension that is set up and provided by your employer. You contribute to pensions savings automatically through your wage, and then employer contributions are added to this.

The combination of these two means that by the time you need your retirement savings, you'll have many years of contributions to dip into. These have several different forms:

Defined Benefit

As the name suggests, a DB pension involves a set amount of benefit in retirement for each year worked. Your pension represents a guaranteed retirement salary in perpetuity.

So each year you work, for example, you might get an extra £1000 in retirement salary. 10 years of working means £10k of retirement income for as long as you live.

These are much less common nowadays as employers realised that people were living longer and it was becoming much more expensive (and risky) to guarantee them long term retirement income until they died.

Defined Contribution

As a result, DC schemes are now much more popular. This means that you contribute a set amount each month.

That is invested in a pre-set pool of investments with a particular mandate and when you retire, you can start drawing down on the large pot of pension savings you have built up in order to live.

Now - in this case, the risk is with the employer rather than the employee - if your pension contributions don't grow as much as you expect them to, no one loses out but you.

It means there is more uncertainty now around required pension contributions and that more care needs to be taken when choosing and managing which pension fund your pension contributions are going towards.

Personal Pension

As a result, it may also be prudent to set up a personal pension. You will be eligible for the same tax relief as you would with an employer pension, but you will be in charge of managing this yourself.

The most common kind is a SIPP: A Self Invested Personal Pension. As the name suggests, you can choose what to invest it in, and you will be able to withdraw a tax free lump sum when you retire, as with a workplace pension.

You can also put property and other cashflowing assets inside a SIPP, making them ideal for some of the more unorthodox financial instruments you may be using to save for retirement. Of course, please do take retirement advice - investing wisely is just as important as how much money you put in.

State Pension

Of course, in addition to the money saved from your annual salary, once you reach retirement age you should, depending on your own circumstances, be eligible for a state pension.

Now, unless you live very frugally this will almost certainly not be enough for retirement in and of itself. However, it provides a useful supplement to the pension plans we've talked about above, and needs to be factored in.

The future of your state pension

Do be aware, however, that depending on how old you are and how much financial freedom you're expecting, the state pension will almost certainly have fallen in real terms by the time you get there!

So as before, you need to be realistic about both your retirement goals and how much you'll need in pension savings by the time you get there. However, it's a useful starting point.

This of course, does not constitute investment advice.

Combining Your Pensions

Now that we've covered off the different types of pension available to you, what's left is to work out what the most effective combination of these will be.

Almost everyone is entitled to a state pension, so you'll be using the calculation we did in Part 1, but forecasting a lower growth rate perhaps to account for inflation and then adding a margin of safety on top.

Of course, the ideal pension pot runs dry on the day that you die, but this is impossible to predict with any degree of accuracy.

Conclusion

So to wrap up: there isn't a set formula or set amount we can tell you to save for a secure retirement. Achieving financial stability most certainly feels more like an art than a science That being said, there are a number of guiding principles that govern the field, some of which we've tried to outline here.

The aim is that you leave with some thinking points that allow you to think about what proportion of your salary you need to save for the future, and highlights the important of starting early.

Employment Status

Of course, the best way to save more is by earning more - which sounds redundant but remember: with a bigger salary, you are able to contribute more of it.

We've also predominantly spoken about those in employment. When you're self employed, the onus is even more on you to be saving responsibly.

Advice

As always with these things, seek professional advice before following instruction on investment strategies that you're not familiar with.

A financial adviser will be able to ask how much income you have available and what lifestyle you need to sustain, and provide you with a realistic retirement savings goal and the correct instruments to reach this.

Managing Your Pensions with Strabo

Many pension providers have taken a little while to adapt to the digital age and provide robust online services.

The more forward-thinking ones provide data feeds that we can access at Strabo and allow you to effectively track your pension values over time.

They feed into our tools like the Scenario Analysis and allow you, with some degree of accuracy, to predict what you might have at retirement in difference scenarios. If not, you always have the option of consolidating your disparate pensions into one pot, something a provider like PensionBee offers.

Finally, you also have the option to manually configure your investments so you can follow along with their performance even if there isn't a direct live feed. Whichever your options, you can sign up to a free trial on Strabo today and check it out for yourself.

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