"The average person is a minority, it is the individual that is important. We need to give more help to the individual to decide the life they want"
“How much do I need to save for my retirement?” is a question that is often asked.
There are a range of answers - many use target replacement ratios. Someone on average earnings is said to need around 60% of their pre-retirement earnings. Take off the State pension of say £8,000 a year and multiply that by (100-a) where ‘a’ is the intended retirement age.
If the shortfall is £8,000 a year and retirement is intended to be at age 65 then you need a fund of around £280,000 if you are going to produce an inflation proofed income that will last a lifetime. For the average person who will retire at age 65 that should be the target.
However, only minorities are average, therefore it is an inaccurate calculation for most people as would any other generalised calculation.
Let us take two people, Nikki and Ian. Both are on average earnings of £26,000 a year. Nikki is single. Her work is such that she has been constantly moving. A year or two in one place followed by a year or two in another. She has always rented and does her best to keep her expenses down by trying to rent accommodation within walking or cycling distance from her work.
Ian is married. He is about to pay off his mortgage just before he retires. His mortgage costs £400 a month. He commutes to work paying £2,400 a year for the pleasure.
Both Nikki and Ian do not expect their retirement spending to be much different to what they currently spend.
It is hard to see how Nikki’s target replacement income will not be 100% of her current income. Assuming a state pension of £8,000 a year she is going to need an additional £18,000 a year which equates to around £630k to fund that income from age 65. A large component of that is going to be her rent which she is going to have to pay for the rest of her life and which is likely to increase each year.
Assume Nikki has to pay £600 a month rent. That is £7,200 a year which comes out of taxable income meaning she must receive £9,000 before tax to pay her rent. To do that requires a retirement fund of around £315k.
Ian has outgoings of £7,200 a year which come out of taxable income and which are going to stop when he retires. Currently he must earn over £9,000 a year to be able to meet those costs out of his net income. Therefore an income of £17,000 a year would fund his current spending. The 60% target replacement income is not far out for him.
Ian is married. His wife, Mary who works part-time in a local supermarket, will also be entitled to a state pension of £8,000 a year. Once that becomes payable they will have a joint income of £16,000.
Statistically, a couple need 50% more income to live together than a single person living on their own. Therefore they probably need a combined income of £25,500 a year based on a spending need of £17,000 a year. Combined they are £8,500 short so they need a combined retirement fund of £297,000 to retire.
Here I have fallen into my own trap; I have assumed that they are an average couple. In all probability they are not.
If either Nikki or Ian retired before State pension age the fund they would need to increase the above amounts to cover the longer period of retirement and the fact they would not receive their State pension until they reached State pension age.
I accept that the above is very simple in approach, but hopefully it illustrates that home ownership, the cost of working and marital status can all have a dramatic impact on the retirement savings that will be required. It also ignores the fact the home ownership does create opportunities to enhance retirement income by either downsizing or releasing equity.
When we are working we generate income. We decide how we spend that income and how much we put aside for the future. This is an individual matter. Retirement is no different. What we spend will vary from individual to individual. What if Nikki or Ian had retirement plans that involved spending more than when they were at work? What if they planned to retire several years after age 65?
As I say the average person is a minority, it is the individual that is important. We need to give more help to the individual to decide the life they want and help them plan how they will finance it.