When saving for retirement, it can be difficult to know how much to set aside, and whether you should focus more on pensions or other savings and investments. Your financial situation evolves throughout your life too, and when your earnings increase or your outgoings change, you might wonder how this should affect your retirement plan.
There are many “rules of thumb” that people use to help answer these questions. However, while they can offer some useful insight, these simple guidelines don’t take your unique situation into account.
Here are three retirement saving rules of thumb that might not be right for you.
1. “You need 10 times your salary in your pension at age 66”
Knowing how much you need to save for retirement can be challenging and ultimately, it all depends on the kind of lifestyle you want to lead. Yet, you may have seen guidelines about how much you should have in your pension at different ages.
For instance, according to the Independent, certain metrics suggest you should have half your salary saved in a pension by your mid-30s. It’s often recommended that you have 10 times your salary in a pension by the time you reach the State Pension Age of 66.
Using this arbitrary rule to decide on a savings goal could make it difficult to build adequate wealth for retirement because it doesn’t consider your personal aims in later life. Crucially, it doesn’t take your planned spending into account.
For some people, 10 times their salary might be more than enough to fund their lifestyle, while for others it won’t be.
For instance, if you currently earn £70,000 a year and you estimate that you’ll spend £25,000 a year in retirement, a pension pot worth 10 times your salary (£700,000) will last you roughly 28 years.
If you retired at 66, this means you could fund your lifestyle until age 94 and if you have other savings, perhaps even until you’re 100.
Conversely, if you have expensive travel plans or want to financially support family members, your spending could be much higher. If you were to spend £50,000 a year, a pension pot of 10 times your salary would last just 14 years. This could mean you’re more likely to run out of money in retirement.
You might want to retire before State Pension Age too, so this goal wouldn’t be suitable for you.
That’s why it’s important to create a retirement budget and consider how much you’re likely to spend each year, so you can determine the level of savings that is right for you.
2. “The percentage you contribute to your pension should be half your age when you start paying in”
As well as rules about how much you need in your pension at certain ages, there are simple calculations designed to help you determine what you should pay in each month.
One rule suggests that the amount you contribute should be half your age when you start paying in.
For example, if you start contributing at age 25, you should pay in a total of 12.5% each month. But if you don’t start a pension until 40, you should pay in 20% a month.
The idea is that if you start saving later in life, you contribute more so you’re still able to build enough wealth for retirement.
However, this rule about contributions doesn’t account for your own personal situation or salary. If you earn a significant amount, a smaller percentage of your salary could be adequate to save for retirement.
Conversely, if your partner is the higher earner and your salary is relatively low, you might not be able to afford the level of contributions suggested by this rule.
This rule doesn’t consider your own retirement savings goal either. In some cases, following this tip could mean your contributions are far too low to reach your target. Alternatively, you might save more than you need to, meaning you make unnecessary sacrifices to your lifestyle now.
That’s why it’s better to consider the amount you save each month and whether this allows you to achieve your dream retirement, rather than focusing on an arbitrary percentage.
When you work with a financial planner, we’ll discuss the goals you have in retirement and the kind of lifestyle you want to lead. We’ll then help you determine how much it’s likely to cost you and use cashflow planning to calculate what you need in your savings pot to achieve your ideal retirement. Using this information, we can work out the level of contributions you need to make each month.
3. “The 4% rule”
When you transition to retirement, it’s important to draw sustainably from your savings so you can maintain your standard of living without running out of money.
In the past, the “4% rule” – only withdrawing 4% of your pension savings each year – has been used as a common rule of thumb for generating an income from your pension.
The thinking is that 4% is a sustainable amount to take from your pensions. What’s more, as your investments continue growing and your pension pot potentially gets larger, 4% gives you a higher income over time. As such, your withdrawals rise with the cost of living and you can maintain the same quality of life.
While this might work for some, there are several key problems with the 4% rule. Firstly, it doesn’t consider your budget and how much you’re likely to spend. In some cases, 4% of your pension might be far less than you need to achieve your dream lifestyle.
Conversely, 4% could be far more than you need, meaning you could unnecessarily pay tax on income you don’t end up spending. You also miss out on potential investment returns on the extra wealth you take out.
The 4% rule also fails to consider market volatility. For instance, if the value of the investments in your pension falls, the income you generate from withdrawing 4% of the total pot will also be lower. As such, you might not be able to maintain your current standard of living.
On the other hand, when markets are performing well, 4% might generate a much higher income than you need. This could mean that you pay more tax because your income is higher, even though you don’t need the additional funds.
To avoid these problems, it’s important to regularly review your budget and take only what you need from your pensions and other savings. With our ongoing support, you can make sustainable withdrawals from your retirement pot and continue to achieve all your goals in the long term.
Get in touch
If you are interested in bespoke retirement solutions built around your goals, we can help.
Please give us a call on 01276 855717 or email info@braywealth.com today.
Please note
This article is for general information only and does not constitute advice. The information is aimed at retail clients only.
All information is correct at the time of writing and is subject to change in the future.
The value of investments and any income from them can fall as well as rise and you may not get back the original amount invested.
A pension is a long-term investment not normally accessible until 55 (57 from April 2028). The fund value may fluctuate and can go down, which would have an impact on the level of pension benefits available. Past performance is not a reliable indicator of future performance.
The tax implications of pension withdrawals will be based on your individual circumstances. Thresholds, percentage rates, and tax legislation may change in subsequent Finance Acts.
The Financial Conduct Authority does not regulate cashflow planning.
Approved by the Openwork Partnership on 08/04/2024
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