Most of our outgoings when we retire will be very different from during our working life. The mortgage has been paid off, you stop paying into your pension, the kids have made it through university, and you don’t need to pay thousands of pounds every year commuting into work. But just how much do you need? A question we all need to ask ourselves as we plan for retirement is “how much income will I need when I retire?”. Without knowing this it is impossible to work our how much we need to save for our retirement.
Not surprisingly it will vary wildly from one person to the next. I’m pretty sure that David Beckham will need a bigger slug of money every year than Barry down the pub. There are some rules of thumb that can give start to give us a guide of how much we’ll need each year. But just how accurate are they? This article focuses on what you’ll need year by year, rather than paying for any large one off purchases.
Rule of thumb 1 – you need 70% of your final income
Many will say that you need 70% of your income as a salary in your retirement. Indeed lots of institutions use it as the main guide in their retirement calculator. And you have to say, it is nice and simple. If you earn £20k now, you need £14k in retirement. If you earn £80k, you need an income of £56k in your retirement.
There are certainly worse things in life to do than to aim for 70% of your income in retirement, but in doing so you might find you just don’t get what you want.
So where does this mythical 70% come from? Firstly, it isn’t just some made up number. It’s the result of a lot of studies including a fair chunk of data from the Department of Labor’s Consumer Expenditure Survey. In fact it also suggests upwards of 80% might be needed for some people. As a measure, it is statistically correct for the ‘average’ person. The only problem is who is this average person? The person that earns an average income, has average spend, average aspirations, lives in an average house with 2 average children, and goes on an average holiday in average resort. Are you average? Of course not! And there is the problem. Not so much with the science, but that as soon as you try to come up with one golden number, you exclude so many variables that it becomes kind of meaningless.
For some people it will give far too high an income for retirement. This is particularly true for higher earners, especially those that are saying hard. I’m a good example of this. At the moment we are saving 35% of our monthly earnings and paying the mortgage which is 15% of our earnings. So that’s 50% of my salary that we won’t need when we retire. This doesn’t even factor in tax and NI reductions. So we could live off 50% of our current income without any changes to our lifestyle, not 70%.
The flip side is that for some, especially lower earners, it may even be too low. Not too low for them to be able retire, but enough for them to retire live the life that they aspire too. And what if in your retirement you plan to actually live a more expensive life with more holidays to exotic locations? Is that covered in the 70%?
There are certainly worse things in life to do than to aim for 70% of your income in retirement, but in doing so you might find you might find you just don’t get what you want. Imagine beavering away in a job you hate for 3 extra years and then realising after you retire you just don’t need as much money. Not the end of the world but a waste of three precious years. Or imagine getting to within a year of retirement and realising you’re actually going to have to work an extra five years to retire how you really want?
The main problems with this rule of thumb is that it is
- Based on your life now, not when you actually retire
- Based on income, and not what you will actually spend
Rule of thumb 2 – the average spend of those retired in the UK
Another potential problem with the 70% benchmark is that its based on US research. It might broadly hold true in the UK but obviously tax systems are different, health care is different, heck even football is different! So what rules of thumb can we use that are bit closer to home?
Which? have recently undertaken some research that looks at what people actually spend when they retire. This gives some really useful insights into what your outgoings might be when you stop working. They come up with three spend profiles:
- £18k to pay the essentials. The average couple in retirement will need £18k for all of the essentials in life – food, heating. So you should assume this as the absolute bare minimum.
- £26k for a comfortable life. Throw in a holiday to Europe and a few extra activities. This is the amount most people spend in their retirement.
- £39k for a life of luxury! Now we’re talking. Or at least we are if you want a new car every few years, golf membership, and a cruise every year.
The above quoted values don’t include tax so if you add that on your looking more like needing up to £18k for the essentials, £26.8k for a bit of comfort, and £43k a more luxurious lifestyle. The tax addition is possibly a bit on the heavy side, particularly if you will be drawing down on investments that are in stocks and share ISA.
Of course though, we are back at that ‘average’ again. I prefer this rule of thumb in that it disregards current income and focuses on what you are likely to spend in retirement. And the span from essentials to luxury is also useful to allow you to pitch the type of lifestyle you are after. But it is still not necessarily what you need to retire on.
You wan’t better accuracy? Throw out the rule of thumb and put in some hard work!
If you do want more accuracy into how much you will need to retire on, there is only really one answer. To go through line by line what you think you will spend in retirement. The nearer you are to retirement the more important it is to get a proper handle on what you will need. This is the only way to really answer the question “How much income will I need when I retire?”.
I’m not a couple!
Yeah, I scoured high and low and couldn’t find any comparative figures for individuals rather than couples. However, a good guide would be that as an individual you’ll need 70% of the total for a couple. So after tax that would be £12.6k for the essentials, £18.2k for a bit of comfort, and £27.3k for a luxurious life. After tax that would be £12.9k for the essentials, £19.9k for a bit of comfort, and £31.3k for a luxurious life. Once again, the tax addition is possibly a bit on the heavy side, particularly if you will be drawing down on investments that are in stocks and share ISA.
Unfortunately retiring as a single person is much more of stretch than retiring as a couple. I explore this a bit more in an upcoming post.
I can’t be bothered to work out the detail – what should I assume?
If the thought of pulling together detailed budget fills you with dread, what should you plan for then? Unfortunately that’s impossible for me as don’t know your circumstances. However I expect for most couples it would fall somewhere between £28k and £39k after tax. And for most individuals between £18k and £27k after tax.
In future posts I’ll be showing how you can relatively easily pull together a pretty accurate view of what you’ll need every year to fund your lifestyle. So watch this space!