16 min Read
15 May 2017

Calculate how much you need to retire when you want

Reader question: How much money do I need to retire?

I have been reading a lot about the pension rules and being able to cash in my pension pot. However, I do not want to withdraw money from my pension in this way as I am worried that it will run out. Also, I don't know how much money  you need for retirement or if I can afford to retire early.

What is the average pension income and how much money do I need for retirement? I'm really confused, any help would be appreciated.

Damien's response

There's been a lot of press coverage over the pension rules, especially concerning how to cash in your pension and whether it is a good idea. However you can't make any sensible decisions until you know how much money you need for retirement. Interestingly a piece of research by True Potential found that people think they need £23,457 a year for a comfortable retirement income. However, the average UK pension pot could only support that income for 5 years. The reality is that the average pension pot would provide just over £6,000 a year, in today's money! So that's a big problem.

The remainder of this article will help you calculate how much you need to retire when you want. It will also show you how much you need to retire early. Plus I will help you calculate how much you should be paying into your pension now.

How much do you need to retire comfortably?

First of all you shouldn’t worry about what the average pension is or what the average income in retirement stands at. How much you need depends on your personal and financial circumstances.

Step 1 – How much money do I need for retirement?

First of all you need to work out how much money you need to retire on. Only then can you work out how much you need to save for retirement.

To calculate how much money you need to retire comfortably first of all write down all your monthly outgoings such as bills. Include only those things that will continue once you’ve retired. Will you still be paying a mortgage? Think about how you are planning to pay off your mortgage.

Then simply total all these figures up to get a monthly figure. For my worked example I will say that I need a total of £1,200 a month after tax as I will have paid off my mortgage. This is the minimum monthly pension I need to retire when I want. That equates to £14,400 after tax a year or just over £16,000 a year gross. That is about right as it is 2/3 of my assumed current salary of £25,000. Two-thirds of your salary is what you should aim for in order to maintain your current lifestyle.

Step 2 – State Pension Calculation

Now that you know your required net retirement income you need to work out how much you are likely to receive based upon your current financial circumstances.

So the next step is to calculate your state pension. Most people, assuming they have paid enough national insurance contributions, will receive a weekly state pension of just under £160 a week. This equates to £8,320 a year. Don’t forget that this is liable to income tax.

Obviously not everyone will receive the full state pension, especially if they have had a significant break in paying national insurance contributions during their working life. For the purposes of this exercise it’s simplest to assume that you will receive the full £8,320. However, while it is possible to find out how much you are likely to receive as a state pension there is no simple state pension calculator as forecasts rely on your personal national insurance record. If you are worried that you have gaps in your national insurance record then you can apply for a state pension forecast to find out what your state pension will be.

So for my example I will assume my state pension will be £8,320 a year gross.

Step 3  – Quick UK pension calculation

You now need to work out what you will likely receive from your own personal pension arrangements. You can do this by using our simple pension calculator. Pension pot calculators can be quickly used to work out what your pension pot is worth (if you have one already) and how much income you will get. I have used our pension calculator to find out how much my pension will be. To do this I entered the following information into the pension calculator.

I have assumed I am 46 years old earning £25,000 a year with an existing pension fund of £50,000. I pay £100 a month into my pension which is matched by my employer. I am looking to retire at age 60.  I also want to take 25% of my pension as a tax free lump sum and use the rest to provide an income in retirement.

The calculator quickly calculates the following retirement figures (in today’s money) if I retired at age 60:

  • Estimated pension pot at retirement £98,032
  • Desired tax free lump sum £24,508
  • Estimated annual income £3,717

Pension pot calculator

Our calculator can show you what age you can retire at; how much pension you need and how much extra you need to save to get the retirement income you desire.

View pension pot calculator

Assuming that you’ve just run the pension calculator for yourself then looking at your personal results, you’ll also see an estimation of the size of your pension pot when you retire, in today’s money. This figure assumes a 5% growth rate (which is the rate the industry regulator, the FCA, use as their mid range assumption) and inflation of 2.7%.

You will then see an estimated amount of tax-free cash (that you can set to a maximum of 25% of your pension pot) which you can have tax-free and an estimate of the gross income you can take from the rest of the pension. Obviously under the pension rules that came into effect from April 2015 you can take as much of your pension as you want as a lump sum, but, remember only 25% will be tax-free with the remainder taxed as income.

You are then presented with a summary (like mine above) of how far ahead or behind you are of the sort of income that you will likely need in retirement, given your current salary.

In my example I am only 22% of the way to getting the retirement income (from my personal pensions alone) to give me the same lifestyle as earning £25,000 (my assumed current salary).

Step 3 – Work out your net retirement income

Don’t forget that income from pensions is taxable. So while the calculated figures are in today’s money (i.e. taking into account inflation) they are gross of tax. You can find out what your net monthly pension will be by using a PAYE calculator.

I’ve therefore added together my state pension and final personal pension amount:

£3,717 + £8,320 = £12,037.

Using the PAYE calculator above my net annual salary will be £11,466 which equates to £955 a month. This is less than the £1,200 minimum requirement I said I needed in Step 1.

PAYE calculator

This recommended calculator will tell you how much your net monthly pension income will be. You can use this tool to work out if your pension will be enough to meet your bills  and other outgoings.

View PAYE calculator

Was it not what you were hoping for?

The chances are that your pension pot is not worth as much as you’d hoped and your retirement income will be lower than you need. So now look at:

How much do you need to save into your pension?

One way to boost your retirement income is to pay more into your pension. To work out how much you would need to pay enter affordable amounts into the ‘personal contribution per month’ section of the pension pot calculator. It will automatically recalculate the amount of pension you might receive in retirement. By playing with this section of the tool you can see how much you need to pay into your pension versus what you can afford.

If you are employed, will your employer pay into your pension as well? Some employers will match the amount employees pay into their own pension. If your employer will match at least part of your contributions it will give your pension pot a massive boost.

Once you’ve tried the above tweaks you need to work out when you can afford to retire.

When can you afford to retire?

If your pension pot is still not big enough to fund the retirement income you want then you may need to consider delaying your retirement. This gives you more time to pay into your pension and hopefully more time for your pension pot to grow. Alter the retirement age in the pension pot calculator to find out when you can retire. How much you need to retire at age 65 is a lot less then how much you need to retire at age 60 or age 55. Also don’t just focus on your pension income…

Do you need your pension tax free cash to pay off your mortgage?

Don’t forget to allow for any withdrawal of tax free cash you plan to take. Alter the amount you plan to take to see the impact on your potential income. By not taking 25% of your pension funds as tax-free cash you will increase your retirement income by up to a third. Is there going to be enough in your pension pot to even pay off your mortgage if you still need to?

Get a low cost pension

The costs applied by your pension provider will reduce your pension pot by thousands of pounds over time, which in turn will reduce your retirement income. So the key is to use a low cost pension. By reducing the projected charges in the advanced settings of the pension pot calculator, you can see what the benefits of a low cost pension could be for you.

One of the most important things you can do is ensure you are using a low cost SIPP or pension to save for retirement. The cost of a pension is determined by the size of your pension fund.

For my worked example I decided to use all of pension pot to provide a retirement income (i.e not take a tax-free lump sum as my repayment mortgage will have cleared my mortgage anyway).

That took my personal pension income from £3,717 to £4,956.

But if I delayed my retirement to age 67 then I receive £7,630 from my personal pension. Add that to the state pension and my gross pension income would be:

£7,630 + £8,320 = £15,950

By using the aforementioned PAYE calculator this equates to £1,250 a month. I also made sure I changed the age on the PAYE calculator to 65-74. This stops national insurance contributions being deducted as they are not payable once you reach state pension age.

In my worked example I’ve managed to quickly calculate how and when I can retire.

The best & cheapest SIPPs - low cost DIY pensions

To help you choose the best pension product we’ve analysed the options available on the leading pension products.

View post

How much money do I need to retire early?

Now that you’ve run the pension calculator you can go back and see how much you need to retire at 55 or at age 60.

To do this set the retirement age on the pension calculator input screen to 55 and run the calculator. Now vary the monthly pension contribution amounts until you reach the level of income required. Bear in mind that if you chose to retire at age 55 or 60 then you won’t receive your state pension until you attain your state pension age. So your personal pension will have to make up this shortfall. By varying the fund size and contribution levels you can see if you can retire early and how big a pension fund you need.

The next step if you’ve not already got a pension

Now that you have an understanding of what you might need in retirement it is important to take action and put your plan into practice. Remember, if you don’t plan for retirement it will never happen. No one is going to do it for you. You can get a low cost pension online with the UK’s leading pension provider with a one-off payment of just £80 or with a regular contribution of £20 a month. Most people spend more than that on coffee each month.

You don’t even have to decide your investment choices to get a SIPP (self invested personal pension) up and running. Plus it only takes a few minutes to set up. It’s popularity stems from its cost effectiveness, excellent customer service and online functionality.

As I said,  if you don’t plan for retirement it will never happen.

Put your plan into action

The earlier you start contributing to a pension, no matter how small, the sooner you can retire

Secure your retirement

Article overview

Key points

  • Follow the below steps to work out how much income you will need after retirement.
    • Write down all of the outgoings that will continue once you’ve retired.
    • Use our pension pot calculator to work out how much income you will get from your pension. Don’t forget to take account of your likely state pension too.
    • Income from pensions is taxable (except the first 25% which is tax free). Use a PAYE calculator to work out your net monthly pension income.
  • If your income is not enough to cover the outgoings calculated in step 1 you have a few options.
    • You can boost your income by paying more into your pension. To work out how much you would need to pay, enter affordable amounts into the ‘personal contribution per month’ section of the pension pot calculator.
    • Alter the retirement age in the pension pot calculator to find out when you can retire.
    • Allow for any withdrawal of tax free cash you plan to take as you may wish to pay off your mortgage.
    • Ensure you are using a low cost SIPP or pension to save for retirement. I’ve analysed the charges on the leading pension products for you in my article The best & cheapest SIPPs – low cost DIY pensions.
    • Remember, if you don’t plan for retirement it will never happen. No one is going to do it for you. You can start a pension online with a one-off payment of just £80 or with a regular contribution of £20 a month. Most people spend more than that on coffee each month.

Written by Damien

Damien is one of the most widely quoted money and investment experts in the national press and has made numerous radio & TV appearances. He created MoneytotheMasses.com while working in the City when he became disillusioned with the way the public were left to fend for themselves because they could not afford financial advice.

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