One thing we often get asked by Phoenix staff is how much you should be saving each month. Fortunately if you are saving for retirement, there are several rules of thumb that you can use.
30 years ago, an American financial advisor calledBill Bengendeveloped the 4% rule. The 4% was the safe annual withdrawal rate from a portfolio to last a 30-year retirement. He later clarified his research to state that this was designed as a “worse case scenario” and that the average safe withdrawal rate is closer to 7% per year.
So, to calculate how much you should target at retirement you can take your expected yearly expenditure in retirement and divide it by 4% to be cautious or 7% if you are happy to bet on your own retirement looking like the average of the historic outcomes.
A lot of people tell us that they don’t know how much they will spend in retirement, but the answer is often, what you are spending in employment minus your mortgage payments (on the assumption that the mortgage will be paid off before retiring). It is extraordinary how similar client expenditure is in retirement compared with during their working life. We achieve a certain standard of living and the get used to having it.
If you want some useful information about what the average retirement spending looks like to help work this all out, then The Pensions and Lifetime Savings Association (PLSA) has established three retirement living standards to help individuals understand the income needed for different lifestyles in retirement. Their research is excellent, and you canaccess it here.
Taking their ‘Moderate’ retirement spending for a couple of £43,900 per annum and dividing it by 4% gives a target retirement savings figure of £1,097,500. Dividing by the more optimistic number of 7% gives a target retirement savings figure of £627,142.
Remember that 4% is the ‘worst case scenario’ but the longer your retirement is, the higher the risk that you will run out of money and so it can make sense to aim for the lower % rate and therefore higher target savings. As recently as 1935, the retirement age was set at 65 but back then the average woman lived to 62 and the average man 58 and so retirement either didn’t exist or was very short. The State didn’t have to fund that generation’s benefits for very long. Nowadays if anything people underestimate their longevity, with 10% of current retirees on track to live to age 100 and the State paying very generous pensions.
Of course, these target numbers can be reduced if you will also benefit from Final Salary or State Pension incomes but remember that often people stop working before either of these incomes start and so have a ‘bridge’ to get them to those key tipping points is important.
Having guaranteed income in retirement reduces your exposure to market volatility, although the US stockmarket has a long-term return of 10% per year, the worse year was -44%. If your entire retirement savings pot has gone down by this much you might have a lean couple of years whilst things recover.
Once you have your target retirement savings number you can then work out how much you need to save each month to get there. All you need is a spreadsheet and the formula: PMT = ( FV * r) / [(1+r)^n] – 1]. Once you have the monthly savings number you can optimise where these monthly savings go by maxing out on the savings that are tax efficient and preferable added to by your employer; pensions, save as you earn, share incentive plans etc and the rest into ISAs.
We are currently working with many Phoenix staffers to plan their savings to meet their personal retirement goals, from our Head Office in Hook, Hampshire and throughout the UK.
