How much is enough for retirement?
We all know we need some money for our retirement. Where we usually fall down is knowing how much.
Retirement planning is not the most popular topic I can think of, but everybody needs to think about it.
Living overseas, I’m forever coming across British expats who don’t even have a state pension. There’s no excuse for this as you can make your national contributions from wherever you are and receive payments even if you don’t live in the UK.
It is a great deal. In fact, it is one of the best returns on investment most investors are ever likely to get.
One of the best returns on investment you can get
Usually, expats will pay Class 2 contributions, although other classes are sometimes required. It depends on your specific situation.
At the time of writing Class 2 contributions are just £2.95 per week. You need to provide 30 years of contributions to enable you to begin to receive payments when you are 65 if you are a man and 60 if you are a woman.
You’d receive £125.95 per week if you started receiving it today. Of course, these numbers are always increasing so by the time you retire, the age you can receive it will almost certainly be higher.
Furthermore, your contributions will have almost certainly increased, but on the bright side, the amount you receive should also have increased.
The average life expectancy in Britain for Females is 83 and Males 79, so right now the average male could expect to receive the state pension for 14 years. This is about £91,691.60. Women of course should get more because they should live longer.
In any case, that’s a pretty good return on a £4,602 investment, not to mention the fact that these contributions also include entitlement to bereavement benefits, contribution-based employment, and support allowance.
How much is enough?
Some people live quite happily on only the state pension, but for a lot of people it won’t be enough for their ideal retirement. So how much is enough for retirement?
Well, that’s all down to who you are and what you plan to do in retirement.
I’m sure it goes without saying that a married couple living in a cheaper Northern city, in a mortgage free house, who are frugal, don’t like traveling, don’t need a car and spend most of their time indoors aren’t going to need as much as single person who lives in central London, rents a home, likes traveling, fine dining and driving classic cars.
There are numerous complex models you can use to calculate how much money you are going to need to retire comfortably. You can even pay a pension professional to tell you exactly how much they think you are going to need, but none of these methods are perfect.
They are all going to make assumptions about a future that none of us can accurately predict. Alternatively, there’s a simple rule that many amateur investors swear by, called ‘the Rule of 300.’
Using The Rule of 300 to calculate how much is enough for retirement
With the Rule of 300, you just multiply your monthly spend by 300 and your answer is the amount you’re going to need in retirement. Consequently, if you currently spend £3,000 a month you’re going to need £900,000 in retirement (3000 x 300).
The 4% Rule
The Rule of 300 is so simple you’d think it couldn’t possibly be any good, but it is! There’s science behind the simplicity, based on another rule of thumb called the 4% rule.
The 4% rule relates to an investment portfolio’s withdrawal rate and is backed up by a lot of research. Simply put, you should be able to withdraw 4% of your investment portfolio every year for a normal retirement period (up to 30 years) without ever running out of money.
Based on this logic, we can work backwards from the £900,000 (calculated above using the rule of 300). If you have £900,000 in your pension pot and you withdraw 4% a year, you’ll have £36,000 or £3,000 a month.
£900,000 x 4% = £36,000 and £36,000 / 12 = £3,000.
Now the 4% rule is not without its critics. You can find plenty of arguments out there for higher and lower values. I’ve seen 3%, 4.5% and 5% argued convincingly. In spite of this, the majority still seem happy to go with 4%.
Inflation
The rule of 300 takes account of inflation because it assumes your investment portfolio growth outpaces inflation, which it should. It also assumes a standard retirement period of up to 30 years.
Without getting bogged down with all the mathematics behind it, the difference in how much you need for periods over 30 years are minimal. In theory, unless something really unexpected happens you’re portfolio could probably last a lot longer than 30 years.
If you are thinking of retiring a little early or you want to edge on the safe side, it might be a good idea to assume you can only withdraw 3% or even 2%. Withdrawing 3% of your portfolio annually would equate to a rule of 400 and a 2% withdrawal would equate to a Rule of 600.
Whatever you decide, this simple rule should you give you a great idea of how much you need for your retirement.
