Saving for retirement is tough, but not nearly so tough as getting started in the first place. To get going you need a retirement plan. To get motivated you can try putting some numbers through a pension calculator.
Did that? Disappointed the predicted outcome falls hopelessly short of your expectations?
You’ve got two options. One is to find a big bucket of sand to stick your head in. The other is to set your face against stony reality and work out a Plan B.
I think you know what to do…
A fine example of a plan
There now follows a pension calculator comic strip showing how a failing plan can be put back on course. But first some plot exposition.
Our hero is Corporate Colin. Colin works for da man, slaving away for 30 grand a year as a counter of bean counters in Nowhere Business Park.
Colin is 30-years-old and if he can pull three cherries on the defined contribution fruit machine then he’d like to retire on £20,000 1 a year, age 65, in 2047.
2047 – that’s 35 years from now. This thought alone is enough to make Colin reach for the cyanide pills but luckily he stumbles across Monevator while conducting an online price comparison and rediscovers his joie de vivre through the medium of simple investment wisdom.
But I digress. Colin harbours some other dark secrets that you should know:
- He intends to divert £300 per month – or 12% of his salary – into his pension fund.
- That maxes out his matching employer contributions at £150 per month, or another 6% of salary. The calculator assumes that contributions and wages will increase in line with inflation (defined as 2.5% a year).
- Colin’s existing pension assets are zero. Which is slightly higher than his level of respect for his boss.
- Colin has a wife and though he can’t understand how she’d want to live without him, he nevertheless selects the 50% spouse annuity option, just in case. That means his significant other will soldier on with 50% of the income in the event of Colin’s untimely death.
- Our protagonist has even dared to read the calculator assumptions, just in case there’s some hidden knowledge buried in there that he can turn to his advantage.
- He understands that the income projected by the retirement project-o-tron is based on annuity assumptions that will probably bear no relation to his situation in 2047.
- He’s happy to have his income index-linked at 3% a year when he retires because he wants to be able to afford beer at £60 a pint in 2067.
- Colin is keeping his state pension out of it. He’s going to get a forecast done, but wants his state pension to be a buffer in case things go horribly wrong.
- In the nick of time, Colin remembers that his £20,000 retirement income will be taxed. A quick spin on a tax calculator reveals that Colin will be living on £18,100 a year, after tax, at age 65. Colin can accept this. It’ll be 2047 after all and the tax system may well look very different. What can you do?
Colin tires easily and can take no more assumptions. So let’s get on with it.
Fire One – The range finder
Colin enters his numbers into the calculator and dreams of a world without emails marked URGENT!
Disappointing. An income of £20,000 after 35 years didn’t seem a lot to ask for but nonetheless, our Col has pulled up short. If he doesn’t take action then he’ll be living on £15,000 – which is 75% of the desired amount.
A diet of Aldi spam doesn’t sound great, so let’s consider some alternative scenarios.
Doing nothing is not one of those scenarios as the ‘delaying for five years’ part of the calculator tells a chilling tale of penury. It really is now not never for our hero.
Fire Two – Reduce costs
As a good passive investor, Colin will use cheap index trackers to hammer down his investment costs. So he goes into the calculator’s advanced options and turns the annual management charge down from 1% to 0.5%.
That move alone makes a pretty big difference – projected income is now nearly £17,000 – but at 84% of the target Colin needs to do more. It’s time to suck down some more painful solutions.
Fire Three – Working longer
With a deep breath, Colin dials away a few more years of his life and delays his retirement age.
Putting another three years onto his working life and retiring at 68 does the job for our masked wage slave.
It amounts to no more than the push of a button now, but perhaps working for longer as a part-timer may be less painful when it comes to the crunch. The £21,000 income is a wiggle-room bonus.
Fire Four – Saving more
“No chuffin’ way am I working for those vampires a moment longer than I have to,” thinks Colin in a rare flash of rebellion. How much more do I have to save for retirement to get out at 65?
Colin’s contributions must go up by another £100 every single month for the rest of his working life to hit his target income by age 65. Though that’s only £80 in actual spending money, thanks to tax relief.
Fire Five – Live on less
Can’t save more, won’t save more? What about getting slash happy on the target income? What difference will that make?
Colin has to shrink his living expenses to £16,700 a year to make his plan work. That’s a steep 16% drop.
There is another string to pull though. It’s marked ‘hoping for the best’…
Fire Six – The big bazooka
The calculator currently assumes an expected annual return on investments of 7%. 2 Colin dances with the devil in return for a growth rate of 9%.
Wow. All Colin’s problems are solved! The projected income shoots up to £32K per year and the target is busted.
Is 9% per annum possible? Yes, but it’s massively risky to bank on it.
Historically a 60:40 equities and bonds portfolio has averaged 7%. But many are predicting sub-average returns over the next decade or so, especially as bond yields have sunk so low. Investors starting in the early 1980s could have comfortably scored a 9% return, but history has not been so kind to market entrants in the Noughties.
You can see how different asset allocations have faired using Vanguard’s Asset class risk tool. (Click on the grid icon when it loads).
The bottom line is that the more you shoot for the stars, the better chance you have of hitting yourself in the foot.
Fire Seven – Trench warfare
As an antidote to the intoxicating temptations of a 9% return, Colin takes a quick look at the 5% per annum return scenario – and promptly chokes on his digestive.
Shocking. Earning a return of 5% a year instead of 7% shatters Colin’s dreams. The projected income of £8,600 is 57% less than he needs and would amount to a catastrophic failure of the plan.
This is the nightmare scenario and it can happen to the cautious and adventurous alike. The prospect of low growth is why most of us must bear risk through our asset allocation but the markets can’t be trusted to behave as we would like.
So don’t be over-optimistic, do all you can as soon as you can, and hope it doesn’t happen to you.
Fire Eight – The scatter gun
Suddenly 7% expected growth doesn’t look so bad, but it still leaves our office survivalist battling to close the retirement income gap. Perhaps the medicine will seem less harsh if it comes in smaller doses?
That does it. By working one year longer to age 66, upping the savings rate another £25 a month (only £20 with tax relief) and cutting income expectations to £19,000 a year, our hero is finally able to create a palatable sacrifice sandwich that doesn’t make him baulk.
Fire Nine – More ammo!
Remember that any retirement plan is about as precision guided as a SETI sweep of the stars in search of ET. Don’t be fooled by the ludicrous exactness of projected income figures. Reality will turn out differently.
Even using a different calculator may get you a very different answer, though the assumptions may seem similar.
Trustnet’s pension calculator projects a much rosier income of £25,000 per year based on Colin’s original inputs and a 7% growth path. But the Hargreaves Lansdown calculator used for the main example is the most transparent one I’ve found when it comes to assumptions and adjustable parts.
Do let us know about your favourite calculator in the comments.
Fire and don’t forget
Your plan will need monitoring and deft touches on the rudder to stay on course:
- Lifestyling – You may want to lower the risk in your portfolio as you get closer to retirement. Bear in mind this may also reduce your growth rate.
- Rebalancing – This technique enables you to stay true to your original asset allocation when market movements cause it to drift.
- Changes in circumstances – Promotions, inheritance, periods of unemployment, and the rest of life’s rich tapestry may prompt you to revisit your plan and adjust your expectations.
- Unexpected growth rates – Periods of spectacular gain or loss may demand a rethink. Maybe you’ll be able to reduce the risk in your portfolio and cruise home in style if the markets smile upon you. Maybe we’ll end up with the 5% (or worse) nightmare scenario and have to work longer, save more, and live on less. I hope not.
If nothing else, an exercise with a pension calculator shows what a grueling marathon building a retirement pot is for the average wage earner. See you at the finishing post.
Take it steady,
The Accumulator
Some good reads from around the Web.
One thing that has put me off investing in gold over the years is people who invest in gold.
At the height of the property boom, smug landlords who’d come to own 5-10 properties and told you that house prices never went down – ignoring any evidence presented that they did – were infuriating.
But they had the good grace not to bring global conspiracies, canned foods and shotguns, or the Mayans and Egyptians into the conversation. They also rarely told you that you were an idiot, or that you were being paid to lie.
At their worst, ‘gold bugs’ do that and more. The lunatic fringe of these investors recite a gabbled litany of sacred truths, acronyms and concatenations to rival a religious order. Non-believers are invariably stoned.
Take the article Cash out of gold and send kids to college by Peter Tasker in the FT this week 1. Tasker points out the gold price has softened, despite European meltdown fears, low interest rates, and imminent monetary easing. He suggests that might be because after rising nearly seven-fold to its peak of $1,900 in just 10 years before falling to around $1,600, the current price might be high enough:
In inflation-adjusted terms, gold remains within spitting distance of the all-time high it reached in 1981. After that it embarked on a 20-year bear market, which delivered a loss of 80 per cent in real terms and a far greater opportunity cost as other financial assets soared in price.
Even now the total market value of all the gold in existence – which, remember, generates a return of precisely zero – exceeds the combined capitalisation of the German, Chinese and Japanese stock markets, with all the productive capacity they represent.
I think those are pretty interesting statistics, at least worthy of consideration.
Here are some quotes from the comments this article received:
- “Wow! This guy has got to be a paid writer for the international banking cartel. What he is spewing out is exactly why they’ve been forcing the price of gold into line with risk assets like stocks. They want people to think this BS. The lack of insight is amazing”
- “This author, Peter Tasker, is 5 cans short of a six-pack when it comes to understanding the Gold market. I would advise the editor of FT that you are known by the company you keep. And if you allow ignorance and incompetence to be passed along for knowledge, you’ll make FT synonymous with stupidity.”
- “This argument is quite silly and does not understand the nature of gold.”
- “Since when has the ‘quoted price’ been a good indicator for anything? Not since Liborgate anyways…”
- “The Dep Premier of China is on record as ‘we are at war with the USD and our weapon of choice is gold’ China is winning this war – with a lot of help from the misguided and uninformed West.”
And so on. A few sensible voices make some good points in favour of gold, but they are drowned out by the noise. It is always thus when anyone questions the cult.
It’s very hard to imagine this kind of hysteria greeting anyone who said that shares were too expensive, that bonds were over-priced, that property had further to fall, or that cash was a poor store of wealth. Gold bugs see themselves as hardened contrarians – odd given so many sing from a facsimiled hymn sheet.
Some of the charges are ridiculous, such as the FT being on a quest to lower the gold price, or hellbent on publishing anti-gold propaganda. The FT has of course run plenty of articles over the years highlighting the case for gold – just this morning it recaps both sides of the argument, including what it terms “strong arguments in favour of holding the precious metal”.
I’ve come to believe that there is a case for an allocation for gold, and I’d like to add to my very small horde stored at Bullion Vault. Every time the price approaches $1,500, I consider buying some more. If I do so, I hope to discover that subscribing to conspiracy websites and inquiring about a Panamanian passport are purely optional.
- Google the title if the article is restricted to you[↩]
Working out how much to save for retirement is the crux of your retirement plan. Every penny you invest in a pension now is a penny that will grow and compound for years to come.
On the other hand, you only live once, and you may not want to endure much more frugality during your working life than you need to in order to meet your retirement income goals.
The most important factors when figuring out how much to save for retirement are the ones you can control:
- Your expected rate of return is under your control only in the sense that you might choose between a tour of the Georgian streets of Bath or the slums of Rio. You can’t predict what will happen but one option is much safer than the other.
- Time horizon is partially under your control.
- Target income is largely under your control.
- Your contribution level, or savings rate, is almost entirely under your control.
The uncertainty of the future makes me err on the side of saving and investing more now, while I still can.
- Overshooting my target means I can retire earlier, at the cost of some shiny things now.
- Undershooting means a future me will have to cling to the treadmill with fading strength, or face up to a retirement less golden than the one I’ve got in mind. I’d rather avoid that fate.
By saving more money, you reduce the chances of one of the less controllable factors scuppering your plans.
Save more as you age
Your contribution levels must also take into account the arch-nibbler – inflation – imperceptibly eating away the value of your pension contributions over time.
Most retirement calculators assume that you’ll increase your contributions every year to keep pace with inflation. Make sure you check your calculator’s inflation assumptions so you understand how your savings rate needs to adjust.
Now is also an ideal time to go back to your budget planner to subject your outgoings to the pointless tat test.
What are you spending money on that you can happily live without? The more unnecessary expenses you can whittle away, the more you can save, and so the less you may need to live on in the future.
Remember that working out how much to save for retirement is just one part of this equation. Check out our main article on how to create a pension plan for more on the other factors you need to consider.
When you are creating a retirement plan, the longer you can let your investments grow, the more options you have. This is because delaying your retirement gives compound interest more time to work its magic.
By playing with various retirement calculators, you can see how postponing the happy day can ratchet up your eventual pension.
Planning to retire later is very handy if you’re saving all the money you can and yet you’re still falling short of your target.
The question you really need to ask then is not “when can I retire?” but rather “at what age should I retire?”
Don’t regret not spending more time at the office
I’d love to retire early (tomorrow would be nice) but I’m a late starter when it comes to saving for retirement, so to establish a realistic finishing post, I initially plumped for retirement at 65.
Triangulating your retirement age, target income, and savings rate on a retirement calculator gives you an initial hand to play. You can then stick or twist from there:
- If you want to retire earlier, how much more do you need to save?
- Alternatively, how much bigger could your income be in retirement if you stay on the hamster wheel for longer?
Few people need to hear reasons to retire early, but to avoid a long, impoverished post-work existence, make sure you consider both sides of the equation.
Who wants to live forever?
Finally, remember that your time horizon isn’t entirely within your gift.
You might want to work for longer, but catch a corporate bullet and find it impossible to get another position at your previous level. You may get ill or become a full-time carer.
The list of things that can go wrong is as long as your imagination.
Equally, many of us don’t appreciate just how long we might live for, which can also be a bleak outcome if you don’t have sufficient money in your very old age to keep you in Zimmerframes and bribes for the great-grandchildren.
Playing with a longevity prediction tool could surprise you with forecasts of your future as a nonagenarian.
‘What if’ scenarios are hard to compute, so you need to leave room for error, as with the other key elements of creating a retirement plan.
How on Earth can you fathom how much income you will need when you retire? A good first step when retirement planning is to know how much you need to live on now.
For a realistic answer, you can use a budget-planning tool like Money Saving Expert’s Budget Brain to capture your current spending.
I like this tool because it’s like holding your finances up to the Snow Queen’s mirror. It will give you the true picture of your outgoings – warts and all – by speaking plainly about areas that might otherwise be overlooked, such as dental expenses or beauty therapies. (I spend a lot on virgin’s blood, myself).
Will I really need so much income when I retire?
It’s commonly held that we spend less in retirement than in the buccaneering days of youth, so you can probably strip out:
- Mortgage payments (assuming you have paid it off by retirement age)
- Work related expenses
- Child related expenses
But retirement isn’t all about sitting atop a hoard of your treasure, saving pennies with coupons / cruising the Caribbean, and writing letters to Radio 4.
For instance, you might consider upping your allowance for:
- Travel costs
- Health
- Heating
- Werther’s Originals
Once you’ve done all that, you should have a reasonable base figure for the annual income you’ll need to hit on the retirement calculator.
A few wrinkles
If you’re having trouble picturing your retirement, try this gimmicky but fun retirement income calculator that can help you visualise a life of permanent leisure luxury.
Meanwhile, this retirement calculator lets you pick your desired monthly income, then crank the handle to see how fortune plays out.
Remember that the higher your target income:
- The longer you will need to save,
- Or the more you will need to save,
- Or the higher your growth rate will need to be (which implies a riskier asset allocation),
- Or some combination of all the above.
Working out how much you will need when you retire is just one part of creating your retirement plan, so do subscribe to Monevator for more pointers.
