One of the biggest challenges we face when it comes to saving for later life is understanding quite how much we need to retire on. We lurch from saving blindly into a pension plan because ‘it’s the right thing to do’ but with no clue whether it’s enough, to the opposite extreme of being so overwhelmed by the enormity of the task at hand that we are paralysed into doing nothing. Here we’ll share how to start the process of understanding how to arrive at a ballpark figure for what you need to be saving to retire comfortably.
But first let’s take a look at the two broad pension categories that exist today.
Defined Benefit (DB) – ah the defined benefit or final salary pension. Often described as “gold-plated” due to its generous funding arrangements, DB pension schemes confer predetermined benefits on its beneficiaries based on their years of service. What this means is that the majority of the risk is borne by the pension scheme provider, i.e. your employer, with less risk for the employee. Provided they remain invested in the pension fund and continue to make regular contributions, their retirement level up to a certain amount is secured. The problem of course comes from this security.
Great news for employees, not so good for employers who have to fund them. You may have seen headlines talking about pension deficits as companies struggle to close widening gaps in their pension pots due to the number of pensioners they have to finance as people live longer, a situation compounded by bouts of poor market performance wiping billions off pension fund valuations. Those pension deficits refer to DB pensions. The funding challenges associated with these pensions led many companies to withdraw them and introduce defined contribution (DC) pensions to newer employees instead.
Defined Contribution – The vast majority of us are invested in some variation of the DC pension. Schemes that are based solely on the contributions we make. Or in other words: eat what you kill. This means, for the savvy pension saver, maximising your pension pots during your peak earning years is the very best way to make sure you are eating abundantly in later life.
But how do you know just how much those pots need to contain?
And with pots of pension from previous employment making it harder to track just how much we’ve already got saved, coupled with uncertainty over quite how much our state pension will cover (spoiler alert: not much), assuming it even exists at that stage, confusion abounds.
So back to the million-dollar question.
How can I gauge what I might need to retire on?
As a rule of thumb, most financial planners advocate budgeting for at least 70% of your pre-retirement expenses over a 20-30 year period.
Here’s how to start the process of figuring out your magic number.
- Current expenses vs future expenses – the best start point is an assessment of what your current income and expenses are and what shifts you anticipate in retirement. Will you no longer have childcare costs? Do you expect your mortgage to be paid off? Will your travel and commuting costs be significantly reduced?
- Care needs provision – In tandem with examining which expenses you expect to be reduced or eliminated, you must also assess and estimate the cost of any new expenses. Perhaps you harbour desires to travel the world in style, for leisure and not business. Longer term care is a big one. As life expectancy increases, the likelihood of additional care needs in later life grows. What are the different options and how much will they cost?
- Understanding of what you currently have – how much have you amassed in private pensions to date and what is the future projected value (check your latest pension statements for this). Include any potential state pension entitlement in your evaluation (you’ll need to check your national insurance record for this).
The final number will look different for different people and will be based on your personal circumstances including target lifestyle in retirement, desired retirement age and proximity to this point. But understanding these factors puts you in a powerful position from which to plan, leaving you firmly in the driving seat of this crucial aspect of your life.
Article by Davinia Tomlinson