What’s your “magic number”
Last week I kicked off my new mini-series on pensions.
I’ll be looking at the types of pensions and savings options are available, for those who haven’t yet started saving…
How to boost your pensions savings, for those who have…
And what options are available to you if you are coming towards your retirement or have just retired.
But first — whether you’ve started saving or not (whether in a workplace pension or a private one), you need to work out your “magic number”…
This is the amount of income you’ll need from your pension pot and/or savings accounts each year to live.
It’s important to try and calculate how much you’ll need each year, so that you can then calculate if your current savings are on track to get you there or you need to start saving more to ensure you don’t have a shortfall.
Now, you’ll never be able to get this figure 100% on the money, for a number of reasons:
Firstly, as a reader pointed out earlier this week, you don’t exactly know what your retirement life will be like and what you’ll want to do in your new found free time.
Secondly, and — sorry for getting morbid on you — you can’t predict just how many retirement years you’ll have to pay for.
Plus there’s whole host of political, social and economical factors can influence your magic number, both before you retire and after.
Wow, with all of that you’d be forgiven for thinking “is it worth working it all out, if it may end up being off the mark?”
Well yes, it is worth trying to calculate an approximate number, as without a number you have nothing to work towards.
Without having a “magic number” in your head — you could spend your life thinking you were saving enough or. as some people do, thinking the state pension will be enough…
And end up with a nasty shock when you come to retire.
Luckily, working out your magic number isn’t so difficult.
It just a matter of following a few simple steps…
Step #1: Calculate how much you spend now.
This is what Creating Wealth contributor, Mark Ford, calls your Lifestyle Burn Rate (LBR).
It’s how much money you need to fund your current lifestyle.
Now, if you’d followed my advice on making and keeping a monthly budget of incomings and outgoings, this step will be pretty straightforward.
As you’ll already know how much you spend each month.
To find out your lifestyle burn rate, just add up all the monthly totals for expenditure you have recorded and take an average.
Add about 10% on to this figure to account for contingencies.
If you haven’t yet started doing a monthly budget yet, you can follow my instructions for setting one up here.
Step #2: Calculate how much you’ll spend in retirement
The common assumption amongst experts is that you’ll need about two thirds of your current salary to live comfortably in retirement.
But that can vary depending on your current salary. The lower your salary the higher percentage of your income you’ll need.
For example, if you earn £12,000 a year you’ll need about 80% of your current income in retirement, whereas someone on £50,000 is likely to only need about 50%.
It can also depend on the lifestyle you envisage living, so it pays to work out a monthly budget for your future self, in the same way you do your current one (i.e. break expenses up in to things like food, bills, entertainment, travel).
Now, by the time you retire you are likely to have paid off your mortgage and your children would probably have left home by then too.
So remember to remove the expenses on your current list that relate to mortgage and children (after school activities, costs of taking them on holiday).
You won’t have the daily commute to pay for either so remember to remove that cost.
And, of course, you will have stopped putting money in to a pension and started to draw on it instead, so remove that expenditure.
You may have extras to add on though, to reflect your changing lifestyle…
You may want to take extra holidays or take up hobbies you don’t have time for now.
While you won’t know how many holidays you’ll take or what hobbies you may start, you can give yourself a (realistic) budget for how much you’ll want, or be happy, to spend on holidays and extra hobbies each year.
The key when adding extras is to be realistic and not to go crazy.
Remember, the person paying for your future self to go on a “six-week cruise” each year in your retirement… is you. That money will have to come out of your pockets right now and every year up to retirement.
Just like giving yourself a monthly/yearly budget for entertainment etc. now — do so with your future self.
One you’ve got a monthly income figure, again add about 10%-15% for contingencies. Then multiply that by 12 to find your yearly income need — your magic number.
Step #3: Calculate your total pension pot figure.
One way of calculating your total pension pot is to multiply your yearly required income by 20 or 25, depending on what age you expect to retire.
Remember — we are living longer than ever before and therefore the amount of years of retirement we have to pay for is going up — especially if you still want to retire at 65.
Insurance company Aviva have an average life expectancy calculator here which will give you an idea of how long you’ll be retired for and, if nothing else, is a bit of fun (apparently I’ll live ’til I’m 94).
The longer you live the more time you’ll have to spend in work or the more years you’ll have to save to pay for.
Step #4: Find out if you are on track to reach your goal
Now you need to work out if your current pensions savings (if you have any) are on track to get you what you need in your retirement.
To do this, you can go online and use one of the many pensions calculators available — like this useful one from the Money Advice Service.
You’ll need to gather information about any current pensions schemes you are in and any other savings pots you have ste up in order to fill this in.
The calculator gives you a forecast about the kind of yearly income you can expect on your current levels of saving.
It also includes a forecast of what state pension you can expect to get based on your current age.
It advises you whether you are on track or whether you are heading for a shortfall and also shows you how much you’ll have to increase your saving/pension contributions to reduce that shortfall.
Another great calculator is provided by Nutmeg which shows you how much your total pension pot would look like depending on your desired retirement income.
This is a good calculator to use if you currently have no pension or very little in your pension pot as it shows you how much you’ll need to start putting aside each month.
Handily, it also let you adjust the inflation rate (the Money Advice service one uses a flat 2% assumption) so you can see how any potential rises in inflation affects how much you need to save a month.
Hopefully you’ll be on track. In the event that you are going to be suffering a shortfall you have a number of options:
- Think about deferring your retirement by a few years or accept that you may have to continue in some form of part time employment during your retirement to suuplement you pension income.
- Lower your retirement expecations (realise you may not be able to live as well as you’d like).
- Start putting more aside for your future now. Either through spending less or making more money.
And here at Creating Wealth we can help certainly help with the last option as we have many ideas to help you make more money.
We can show you plenty of ideas for boosting your income both now and in the future.
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