PLEASE NOTE: If you haven’t read Part 1 of this piece I recommend you start with that, before reading on, you can find it here.

Calculating how to reach your Target income

• Making calculations years into the future is far from easy, for starters we might all be retired in 30 years with Artificial Intelligence (AI) and robots doing all our work for us. Even without considering massive changes like that, making calculations is harder, a couple of percentage differences in estimating your figures can make a massive difference in the long run.
• For example, if your aim is to achieve a £20,000 income in retirement, then what total sum do you require? If you assume you’ll be able to average an 8% return rate over the next 30+ years and assume 2% inflation, you probably conclude you need a portfolio of around £350,000. Now, if you change those numbers slightly and use more conservative figures, say 6.5% return rate and 3.5% inflation, then you’d need £650,000 to achieve that same £20,000 a year in retirement. That is a £300,000 difference, massive!
• My suggestion is to take the middle ground, for my calculations I usually use 2% inflation and between 6 – 7% return. The key is not to underestimate the amount you’ll need, it’s better to put more away now and then in 15 years’ time realise that your retirement fund has done better than expected, than you realise you are significantly short.
• Whilst inflation and return rates are two of the biggest factors you need to consider, the other two big ones are;
  • Your spending % – I.e. once you retire how much money will you need to live the lifestyle that you want. This will vary from person to person, to see what my figure is check out the ‘Where I’m currently at’ section below.
  • Your saving % – I.e. what % you save of your income into your pension over your working life. It will almost certainly fluctuate over your working life, due to many factors, including; the percentage your employee pays in, this usually increases the older you get; and what stage of life you are in. For example, I am putting a higher percentage in at the moment because I know I have more disposable income now than I will when I have children, and obviously, the more money I can put away now the more time it’ll have to increase in value.
• The final thing to consider when calculating your potential retirement pot in 25+ years is the management fees you are paying on your retirement savings. This is another great example of how the odd percentage point can make a massive difference to you. For example, if a 25-year-old saves for 40-years for a pension, paying fees of 1% a year, accumulated charges will reduce the retirement pot by 25%. If paying fees of 1.5% a year, that becomes a 38% cut in pot size. Given that most money managers don’t beat the market in the long run, the biggest consideration for me when choosing where to invest my retirement pot is low fees, the lower the better.

What I want

• I want to be in the financial position to be able to ‘retire’ at 57, given the retirement age for millennails is expected to be 70 that is a considerably early. This doesn’t mean that I will never work again, it simply means that by the age of 57 I want to be able to choose whether I want to continue working, in whatever capacity that might be. I want to have the complete freedom to pick and choose, only doing things that truly excite or are of value to me. I hope that there will be things I love doing at that age which will pay me some money, but I’m hoping that by 57 I’ll no longer HAVE to work to lead the lifestyle I want.
• However, I don’t want to sacrifice my lifestyle now to achieve that, I want to enjoy my life, reward myself occasionally, and not put off the good things. This is a hard position to reach, and to achieve it will require dedication and commitment.
• If I was going down the severe route, I’d be saving 70-80% of my monthly take home salary, and not truly enjoying my life right now. The opposite end of the spectrum is saving nothing, or 5-10% of my monthly take home salary. If you follow that model and you’ll be able to retire eventually, and hopefully comfortably, but not early.
• Therefore, my plan is to save 25 – 35% of my take home salary each month until my retirement to have enough.

• As long as I’m working for 35 years – the time required to get full NI contributions – I’ll get the UK state pension of around £150 per week (or £8,000 a year). You might now see why I choose 57 as my target retirement age. I started working at age 22, so by age 57 I’ll have my 35 years of full NI contributions.

Where I’m currently at

• While the section above highlights my hopes and my dream position, I’m not quite optimistic enough to think that if I close my eyes and cross my fingers tight enough that in around 30 years I’ll be able to retire comfortably. I’ve got an excellent idea of where I’m currently at, and a fairly good idea of the plan I need to put in place to achieve that goal.
• I know how much I take home each month, after paying tax, national insurance, my workplace pension and student loan. After those have been automatically taken out I’m left with what I consider my ‘spending money’.
• So far, so good… I think. However, there is one critical factor which hasn’t been considered yet, my spending rate. I have never been good at keeping a budget, I’d say I’ve always had a pretty good idea how much I spend, but I’ve never been able to track it consistently for more than a month or two. This is something I’ve been trying to change recently and I’ve started tracking again, whilst it remains in the early stages I think I have a pretty good idea what my spending is.
• If I follow the rule of thumb, then I’ll need 80% of that figure in my retirement, or around £21,000 per year.
• So, I know what I save each month and what my expected spending requirements will be in my retirement, therefore it’s calculation time.
• Let’s start with the some very important assumptions:
  • My salary remains the same for the next ~30 years (although inflation is included)
  • My monthly pension contributions remain the same.
• Based on these assumptions and using my Companies’ ‘Pension Calculator’ to retire at 57, I’d currently only get around £19,500 a year. To hit my £21,000 target that I think I’d need to retire with ‘financial freedom’ I’d need to increase my contributions slightly. Although I’m not currently hitting exactly what I want to, why am I happy enough?
  • I expect my salary to increase at more than just inflation over the next 30 years of working.
  • I expect my contributions will naturally increase as I head closer to retirement, both in terms of employee contributions and also my own contributions, once my student loan is paid off, I’ve purchased a house and had children.
• Earlier I mentioned I wanted to be saving in the region of 25-35% of my ‘take home pay’ (salary minus tax, national insurance and student loan payments) for pension saving. Currently 22% of my overall take home pay goes directly into my pension pot. On top of this an additional ~15% of my take home pay goes into other investments I have which range from stocks to cash, stocks & shares and Lifetime ISAs. This means that currently I save 37% of my take home pay each money, which falls nicely in my 25 – 35% bracket given not all these savings will end up paying for my retirement.

Conclusion

• So many people switch off and don’t take pension saving calculations seriously because they see it as boring and too far away to worry about, especially millennials.
• Given the increase in life expectancy, the rise of automation and intelligent machines it is a topic which millennials need to spend a little more time thinking about and planning for. It is made even more difficult by the unknown factors and the fact that small changes in the percentage points you use in your estimates, in the long run, can make a large difference to what you might need.
• I hope that the detail above has removed a large amount of the leg work required to calculate what you have and where you are at. I encourage you, while the information is fresh, to spend 30mins mapping out where you stand and then put the automatic saving processes in place so you can go back to enjoying and living life with the knowledge that you’re building a nest egg today that’ll protect you in the future.
• Financial freedom is attainable for anyone, regardless of your income, you just need to plan, save, and understand the lifestyle you want to live in to have that freedom.

 

Missed Part 1 of this blog, check it out here.

N.B. I have purposefully not discussed including your house value in retirement saving calculations. Predominately because I will shortly be releasing a detailed article on housing purchasing. The key message I have right now is this; don’t be ‘house poor’, i.e. don’t live in a beautiful house that costs all the money you have to live in it. Buy a house that is right for you but minimises cost, putting money into your house for maintenance, fixing, and other liabilities costs, stops you saving for your early retirement.

 

Photo Credit.