As financial questions go, my late father regarded this as a big one we all need to answer: how much do I need to retire?
There are various rules of thumb you can apply so you can answer this big financial question. As a rough guide, some financial planners might suggest you need enough in your pension pot to provide the equivalent of two-thirds of your salary from employment.
We used to consider a £1m pension pot as the basis of a financially sound retirement, big enough to generate what is needed in later life. This £1m pension pot rule of thumb would have typically seen the majority of investors through their later years, assuming they didn’t spend excessively, especially during the early years of retirement. However, in recent years, a combination of factors has prompted a rethink of how much is typically needed in savings, pensions and investments in order to sustain a required level of retirement income.
A big driver of this need for more is that we are, on average, living much longer. Sadly, my father died at 60. Considerable improvements to life expectancy were experienced throughout the 20th century, thanks largely to health improvements for younger people, such as immunisations. Since the 1950s, it has been health improvements for the older population which has driven life expectancy higher. Back in 1980, life expectancy at birth was 71 for men and 77 for women. Fast forward to 2011 (the latest year for available statistics) and those ages have risen to 79 and 82.8 respectively.
Of course, these are just averages. 50% of people will live longer than these average ages. Those who engage in the financial planning process, who tend to be wealthier, typically have a better life expectancy than average. With longer lives comes a need for larger pension pots.
Another factor driving the need for greater retirement savings is the rising cost of living. One million pounds isn’t what it used to be! Price inflation might be relatively low at the moment, but even modest annual price inflation over extended periods of time can dramatically increase the cost of
living. This cost of living increase has exceeded 70% over the last twenty years, pushing up the amount of pension savings you will need to maintain the same standard of living as previous generations of retirees.
In order to keep pace with the rising cost of living in retirement, you need a bigger pension pot.
One more factor driving the need for a bigger pension pot is a lower return from investments. In the low interest economic environment which followed the global financial crisis, it takes a bigger pension pot to secure the same level of annual retirement income. Yields on the benchmark 10-year government bond (Gilt yields), which is a widely used reference point for pension annuities, stand at 1.19% today. Around twenty years’ ago, the yield was 7.4%.
With lower returns from investments today, a larger pension pot is needed to generate the same level of income in retirement.
Despite a trend towards needing a bigger pension pot to afford retirement today, it’s worth remembering that we are all different and have differing financial needs and goals. It would be wrong to apply a simple rule of thumb and expect to get an accurate answer to this big financial question.
A pension pot valued at £1m will be sufficient for some. Others will need more and £2m worth of pensions, savings and investments will be closer to the target.
The amount you need to save to retire comfortably is going to depend on a range of factors; when you plan to retire, how much income you need, the amount of investment risk you are willing to take, whether you face any health challenges, and much more.
With the help of Wells Gibson, it is possible to quantify precisely how much you need in order to achieve and maintain the life that’s important to you without the fear of running out of money.
My father ran out of life, just make sure you don’t run out of money!