How much do you need to retire?

It’s a seemingly simple question but getting the answer right could have a huge impact on your ability to provide for yourself and your loved ones after leaving work.

In days gone by, planning the financial side of retirement didn’t involve many choices. How much you’d get under a workplace or ‘defined benefit’ pension scheme was based on your salary and how long you’d worked. If you wanted a decent income after leaving, you’d work hard and hope that would translate into a healthy pension.

Nowadays, there are more choices to make. Unlike workplace pensions, personal or ‘defined contribution’ pensions are based on investment returns, not employee service.  

The responsibility is now on workers to make a financial plan – and to answer the question of how much is enough to retire. In effect, understanding what their number needs to be…  

Various rules of thumb offer apparently straightforward answers. You may have heard that if you don’t spend more than 5% of your pension savings each year, you should be ok. This adage indicates that 20 times your annual expenditure is enough to retire on. Unfortunately, the assumptions behind this are outdated, and basing your future on a back-of-an-envelope calculation could leave you facing hardship in later years. Large moves in external factors such as interest rates and inflation rates can significantly affect the size of retirement pot you might need which aren’t captured in such a simple calculation. On top of these external factors are changes in personal circumstances that no basic multiplier can address.

Your cash flow model

If a simple formula can’t tell us how much is enough, what can? The answer will be familiar to anyone who’s run a business: a cash flow model. Projecting income and outgoings – and a range of ‘what if’ scenarios – allows savers to take control of their retirement.  

A good starting point is your expected outgoings in retirement:

• Basic expenses - household bills, food and other necessities – what you need
• Leisure - dining out, sports and hobbies – what you would like  
• Luxuries - holidays and other large, discretionary expenses – what you would want  

Putting costs into categories helps define how much you need to live on in retirement (basic expenses), and it also gets you thinking about how your costs may change. Many will prioritise spending time with family and travelling, in the early years of retirement, but this may change with age.  

Take a hard-headed look at care costs. Research carried out by Age UK in 2024 suggests that the average cost of nursing homes is around £1,078 per week, though it can be much higher.¹ While releasing capital from your house is one way to cover these costs, a scenario to consider is that one-half of a couple needs full-time care while the other wishes to remain at home. We have seen all of these scenarios and can help guide you through them to make sense of what to plan for.

A question of time

How many years you expect to spend in retirement is another vital input. Arguably, the most important!

The Office for National Statistics provides a free tool that will give you an indication of your life expectancy.² Based on a woman born in 1969, their tool shows life expectancy is 87 years.

However, it also shows a 25% chance of living until 95 and a 7% chance of reaching 100.

If they base their income needs on living to 87, they face a one-in-four chance of spending the best part of a decade without enough money to provide for themselves. Your model should consider that you could live for a long time, particularly if you have a healthy lifestyle and come from a long-lived family.

Leaving a legacy

The possibility of unspent capital at the end of your life naturally leads to the question of legacies. Is your goal to provide a decent standard of living for yourself post-work, or do you want to pass something on?

If you want to give money to your family, it’s worth passing on at least some of this sum earlier rather than later. Seven years after a gift is given, it falls outside the scope of inheritance tax, so planning can help provide clarity and simple strategies to retain more wealth between generations.

Houses and businesses feature heavily in legacy planning. If, however, you want to use a house or business to help fund your retirement, consider potential complications.

As was highlighted by the pandemic, the value of a business can fall rapidly due to unpredictable events. And even a business that remains viable needs a willing buyer to turn it into cash – such buyers may be in short supply at times of panic. Plus, you need to ensure it benefits from all available reliefs.

While ‘bricks and mortar’ is synonymous with a steady asset, selling a house in a falling market may prove painful. Houses also have emotional ties. None of this stops your house from being a part of your retirement planning – indeed, it should feature – but houses shouldn’t be thought of as ‘cash’. Indeed, the common misconception of downsizing is fraught with challenges and reality is often far less attractive than it may have seemed.

Disaster planning

When we think about pension disasters, the most obvious one is perhaps a stock market crash. This risk highlights the importance of a diversified portfolio (one that contains bonds and alternative investments as well as stocks), but for most, it’s not the most pressing one.

Instead, an unexpected family emergency – perhaps one of your children needing cash to save their business or family home – is the event most likely to derail plans.  

Your model should allow you to see how a large, unexpected expense could affect your ongoing income.

Making the most of your wealth – practical steps

Anyone thinking about retirement should check their state pension entitlement. Although the state pension alone won’t provide for anything approaching a comfortable retirement, visit the government’s state pension forecast page to learn how much you can expect to receive, when you will receive it and how to increase your entitlement.³ If your National Insurance contributions aren’t enough to claim the maximum, it may be possible to top them up.

During our working lives, we tend to think of our salary in ‘gross’ terms, meaning the amount you are paid before tax. However, it’s ‘net’ income that matters when covering retirement living expenses.  

While the overall burden of tax stands at a record level, there are still some important exemptions that could help maximise your retirement income:

• £12,570: tax-free personal allowance (for those with an income below £100,000)
• £3,000: annual capital gains tax allowance
• £500: tax-free dividend allowance
• Up to £1,000: savings allowance for basic-rate taxpayers
• Tax-deferred capital withdrawals from single-premium insurance bonds
• Tax-free income/capital withdrawals from ISAs (Individual Savings Accounts) non-executive director fees/consulting income
• Up to 25% tax-free lump sum from a pension fund (capped at 25% of the Lifetime Allowance)

Everyone’s tax circumstances are different, and not every tax exemption will be suitable for you.  

The good news is you don’t have to tackle this alone. A qualified adviser can help you make the most of the money you’ve saved for retirement and achieve your goals in later life.

Sources

1. Age UK, 06 April 2024 - https://www.ageuk.org.uk/information-advice/care/paying-for-care/paying-for-a-care-home
2. Office for National Statistics - https://www.ons.gov.uk/peoplepopulationandcommunity/healthandsocialcare/healthandlifeexpectancies/articles/lifeexpectancycalculator/2019-06-07
3. GOV.UK - https://www.gov.uk/check-state-pension