Planning for your retirement can be exciting. You may want to travel to the places on your bucket list or perhaps start a new, adventurous hobby. Whatever you are planning, you’ll need to think about the funds to support the lifestyle you want in retirement.
According to wealth management and financial planning firm Saltus, there are many elements to consider when planning for your retirement, such as your day-to-day expenditure, larger ad-hoc payments, and ensuring that your capital lasts as long as you require.
There can also be some misunderstandings about how much you think you need for your desired retirement, compared to the reality of the situation.
So, how much do you need to retire and how much should you have invested?
The 4% rule
In 1994, William Bengen — an economist and financial adviser — developed the 4% rule. Sometimes known as the ‘safe withdrawal rate’, it was his aim to give retirees the confidence they wouldn’t outlive their savings.
Bengen analysed 50 years of historical returns across every asset class, from 1926 to 1976 and evaluated the longevity of a portfolio. His results determined that if an individual took annual withdrawals of 4%, the pot would always last 30 years, regardless of when someone retired over a 50-year period, and in all circumstances.
Each year you would then adjust this amount by the rate of inflation to dictate the amount withdrawn. The ‘4% rule’ phrase was therefore coined from the results he documented.
In recent years, there has been some questioning of whether Bengen’s 4% rule remains valid, and there are some issues to the approach. These are as follows:
- It doesn’t take into consideration future return rates
- It relies on withdrawal rates being consistent, which is unrealistic
- Although it does allow for inflation, withdrawals could be for longer than 30 years
- It takes all asset classes into account in all scenarios – results would differ greatly for 100% equity portfolios, for example
- It assesses markets up to 1976, not accounting for modern market reactions and global changes
However, the 4% rule has proven reliable through a wide range of difficult markets. This approach can be a beneficial starting point for those who are just engaging in their retirement planning, and provides an estimated figure.
State pension
When it comes to how much you should have invested at retirement, it’s also worth considering if you’re eligible for a full state pension. For example, if you’ve made 35 years of National Insurance contributions, you’ll receive £9,339.20 per annum, when you reach state retirement age.
The full, new flat-rate state pension (for those who reached state pension age after April 2016) is £179.60 a week. At present, the triple lock is to be suspended for the 2022/23 financial year, and the state pension will be determined by either inflation or 2.5%, whichever is higher. After the tax year 2022/23, the triple lock is to be restored until 2024.
When planning for retirement, you can use your state pension alongside Bengen’s rule to calculate a rough estimation of the pension pot required. For example, if your individual desired income for retirement is £33,000 and you receive a state pension of £9,339.20, the shortfall would be £23,660.80. Taking this amount and dividing by 4% provides a rough estimate of £591,520.00 as the pot required.
On the other end of the scale, if your desired income is £100,000, then the shortfall will be £90,660.80 minus the state pension. This amount divided by 4% comes to a total of £2,266,520.00 as the pot required.
The best approach
As previously mentioned, there are some issues with Begen’s approach to retirement. Therefore, the optimum method to determine how much you need to invest for retirement, is having a bespoke cash flow plan with the guidance of an expert financial planner.
This can be catered to your specific needs and circumstances, adapting an appropriate approach, allowing for any anticipated capital expenditures and accounting for a range of future market returns.
Disclaimer: Information is correct to the best of our understanding as at the date of publication. Nothing within this content is intended as, or can be relied upon, as financial advice. Capital is at risk. You may get back less than you invested.
