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Do you know how much you should have saved for retirement? Do you even know if you’re saving enough to ever retire? These are the simple fundamentals of retirement savings that will tell you how much you will need, and how much you should be saving, for retirement at any age.
This is a question I first asked myself about a year ago. I knew I was paying into a pension as an amount is taken from my paycheck every month. I also know that the UK government is supposed to pay me something. Eventually. If there is any money left at that point.
But will that be enough? What would my retirement look like? Cat food? Or was it the other way around? Was I putting too much money towards my pension that I could enjoy today?
I had absolutely no idea and with my 40th birthday looming I decided to dive down the rabbit whole of pensions. What I discovered changed my whole approach to personal finance!
How Much Money do You Need to Retire?
The 4% Rule (of Thumb)
William Bengen published an article in 1994 looking at what is known as “the safe withdrawal rate” – the amount of money you can withdraw from your investments without depleting them.
This was followed in 1998 by the famous “Trinity study” published by Cooley, Hubbard and Walz at the Trinity University, showing that you can safely withdraw 4% of your investments over 30 years with a low likelihood of running out of money.
To simplify the math, this means that you need 25 times your annual expenses in order to retire.
Since the study was completed this has been tested and debated and the exact % (safe withdrawal rate) will vary between 3-4% depending on your asset allocation. (How much cash, bonds and stocks you have in your portfolio.)
Financial independence blogger Big Ern at Early Retirement Now has written a very good blog post series really diving into the ins and outs of determining the safe withdrawal rate for anyone who wants to really understand this concept.
With that caveat in place, for our purposes we can use the 4% rule of thumb:
How Much Should You have Saved for Retirement Using the 4% Rule?
Let’s say that you want to live off £40 000 per year in retirement. That’s between £2 500 – £3 300 pounds per month depending on if you need to pay tax on it.
(In the UK you have 25% of your retirement money tax free. On the rest, you will pay standard income tax.)
The 4% rule of thumb states that you need £40 000 / 25 = £1 000 000 to retire.
Don’t fancy saving up one million quid? Take a look at your personal financial situation and see how much money you think you will need. Will you have paid off your mortgage at that time? Will you still need the same amount of money for clothes and transport when you’re not working?
If you need help figuring out how much you need Which? Magazine has a great article on How much do people spend in retirement?
This shows that the average retiree spending £25 000 a year which would be equivalent of savings of £625 000.
If you want to include luxuries such as long-haul trips and occational new cars this goes up to £40 000 requiring 1 milion as mentioned above.
And this is per household, not per person mind.
How Much Should You have Saved for Retirement?
The financial independence blogger Mr. Money Mustache visualized this very clearly in his article: The Shockingly Simple Math Behind Early Retirement. He showed that when you can retire, is directly related to your savings rate.
Say that you earn £40 000 per year and you save £4 000 per year for retirement. That gives you a £4000 / £40 000 = 10% savings rate.
It also shows that you are currently living on £36 000 per year, which according to the 4% rule of thumb states that you will need £36 000 * 25 = £900 000
(If you are planning on spending the same amount in retirement.)
Looking at the table below, a 10% savings rate works out to needing to work 51 years in order to retire. For a 20-year-old, this means retiring at 71.
What About State Pension?
Many countries, including the UK, has some version of state pension: An amount of money that we pay in from our wages and that the government then will distribute as an income from a specific year.
In the UK this is currently from 66 years old but it’s expected to be increased to 67 in the next 6-8 years. After this point, if you have worked the qualifying years, you will get a maximum of £175.20 per week which equates to £9 110.4 per year or £759.2 per month.
Take a look at your expenses. Can you live on that?
You may also want to ask yourself:
Do I want to have to work until I’m 67?
Do I believe that the retirement age will stay at 67 or will I be made to work even longer?
Do I think the value of the state pension will be the same when I retire?
Do I believe in the state pension so absolutely that I’m willing to bet my future on that money coming in?
If you do decide that you believe in your state pension, social security or whatever the terminology may be in your country, you can factor it into your pension plan.
How Much Should You have Saved for Retirement Including State Pension?
In the example above, this person has annual expenses of £36 000. If they are planning to keep the same level of expenses in retirement, they would expect to get £9 110 from the state pension meaning that they will have to save enough to cover £26 889.
Using the 4% rule that means they need to save up £672 240 by the time they retire. And if they want the option of retiring a few years early, they would also need to save up to cover that time.
The amound needed to retire has gone down from the previous £900 000 as the state pension is included. That’s still a fair bit of money to save up!
How Much do I Save for Retirement?
I first started saving for my pension when I started in my current industry at age 28. I was luckey enough, my company offered a pension scheme with an employer match.
That first year I was at a very low salary living in London. I had a long, expensive commute, and I decided to go for the minimum amount I needed to save to get the employer match. This meant I was in total saving 7% of my salary.
I personally don’t want to count on the state pension as I’m not sure in what form it will be around when I retire. Looking at the table above, if I had continued a 7% contribution I would have looked at working around 60 years.
That would have put my retirement age at 88. 88! And I thought I was doing well to have started saving for retirement before I was 30!
Over the subsequent years I increased my total contributions (including the employer match) to 15% thinking I was doing really well and looking in the table above I was doing better. I was now looking at 43 working years and would therefore be able to retire closer to 70….
After reviewing my savings rate and my priorities, over the past year I have managed to increase my savings rate to 65%!
I know that sounds insanely high but as I’m already over 40 and I would like to have options in the future. By focusing on creating those options for myself I ensure that I continue my working life for how long it serves me. Not for how long it takes for me to catch up with the ever changing state pension.
Finding What Works For You
The earlier you start to think about your retirement plans, the lower savings rate you can “get away with”. I encourage you though, to take some time to think through what options you want in your life.
How long to you want to have to work? In the blog post Value-based spending we explored the concept of spending in accordance of your values. How does this fit with your current savings rate? Are you only working to pay others or are you working to create options for yourself in the future?
Would you get greater piece of mind if you had a plan and followed it by paying yourself first? Would you be willing to spend less now for more freedom in the future?
The answer to all these questions is highly personable. I encourage you to to play around with some numbers to help figure out your priorities. What is the savings rate where you could let your shoulders down and feel calm that you have the life you want now, but your future is still taken care of?
How much should you have saved for retirement?
Retirement and Investment Calculators
If you want to play around with some numbers to find out how much you should have saved for retirement, here are some good calculators to help you along the way:
Play around with the future value of your money depending on your starting point, monthly contributions and expected inflation rates and rate of returns.
Calculate your time to retirement based on your savings and expected retirement expenses. Make sure you go into the “options” section where you can change your planned retirement spending and add a retirement income if you want to include the state pension.
Does basically the same as the Nerdwallet calculator but gives you more options around expected inflation and taxes to customise it to your situation.
A final word of caution is that most traditional retirement calculator are based on replacing your current income rather than cover your expenses. (And often also buying annuities instead of using the 4% rule of thumb.)
This will make it look like you need an insane amount of money! However, as we have seen in this post, it is really your expenses that will decide how much you need. By lowering your expenses, the amount of money you will need to retire will go down significantly.
By increasing your savings rate, the time until you have the possibility to retire will decrease significantly!