How Much Money is Enough Money in Retirement?

Written by Karen Bryan

£10 and £20 notes3Do you feel like you’re trapped in the cycle of making money, but it never seems that you have enough money to live the life that you want? How much money is enough money?

The first thing to do is to work out how much your preferred lifestyle will cost. Then work out strategies to achieve the required amount of cash.

I’ve been grappling with this issue with regard to retirement.

I estimate that for a comfortable retirement, based on today’s prices. I’ll need a net income of £15,000 per year. That’s on the basis of being married, so having two incomes in the household, and owning a property outright, therefore having no mortgage or rent to pay.

However there are several issues, outwith my control, that I have to take into account.

Inflation

If energy or food prices sky-rocket, that would significantly eat into my income, as these are essential expenses.

How Long Will I Live

If I knew for how many years I’ll live, then I could apportion my savings to cover my lifetime. If I spend too much, I could run out of income in later life. If I am too conservative, I won’t get the benefit of my savings.

Health

If my health becomes poor as I get older, I may not be able to keep working, need to pay for assistance or even go into residential care. An income of £15,000 wouldn’t cover full time care.

External Changes

If a future UK Government started to tinker with the tax and pensions regime. this could affect my income. If annual personal income tax allowance increases significantly, I might pay no tax on my pension and savings income. At present, on an annual income from employment and pensions of £15,000, I’d pay £880 in basic rate income tax. Therefore I’d need a gross income of £15,800 to have a net income of £15.000. Paying no tax would significantly increase my net income.

It’s also possible that the UK Government may start to means test the State Pension. If you have additional private or occupational pensions and/or savings over a certain threshold, you may not receive the full State Pension.

My Calculations

From April 2016, the revised UK State Pension is due to be paid at the rate of around £150 per week, as long as you have 35 years of National Insurance Contributions or credits. That’ll give me an income of £7,800, more than half way to my target of £15,000.

However, I still have another four years of National Insurance Contributions to pay before I’ll qualify for a full State Pension. I have ten years to go until I reach State Pension age of 66.

When I was 55 last year, I used my stakeholder pension pot to buy an annuity, which pays me an index linked (RPI) annual income of around £3,600. Adding my State Pension to this, that’s my income up to £11,400, leaving £3,600 to reach my goal of a net income of £15,000.

The only way to guarantee that additional index linked income of £3,600 would be to buy another annuity. But that would require a lump sum of more than £100,000. It’s also inflexible, in that once your buy the annuity, you have no control over the pension pot. Plus, annuity rates have dropped in last year.

Instead, I could use a pension pot that I build up over the next ten years for more flexible income drawdown, where the remaining balance of the pension pot (after withdrawals) would be in my control. The downside of that is that it wouldn’t guarantee an index linked income for the rest of my life. If I put my pension pot into a stock market based investment it could rise or fall in value. If I left the pension pot in cash, it wouldn’t retain its spending power, unless 0% inflation becomes the norm (highly unlikely in my estimation).

Although I plan to work, at least part-time, as long as possible, I can’t guarantee that income as I’m self-employed.

I require a fair chunk of my current income from my websites to cover living expenses, so that doesn’t leave me with enough cash left to build up a large enough sum over the next ten years to significantly increase my retirement income.

Also, being self-employed means no employer contributions to build up my pension pot.

I’t be risky to say that I’d use my savings to cover that £3,600 annual shortfall in retirement, by taking regular withdrawals from my savings. My savings could run easily out if I live well into my 90s, or if interest rates stay low and inflation increases.

Conclusion

The solutions which I can see to plugging the retirement income gap are to significantly increase my earnings for the next 10 years, and/or take risks with my savings in the quest for a higher potential return.

I could use that extra cash to either increase my savings, buy another annuity, and/or build up a large enough pension pot to provide an income top up though income drawdown during my retirement. Then, I’d still have my current savings to fall back on.

At the same time, I want to enjoy life for next ten years, not be predominantly focused on saving more money towards retirement. But, if I don’t build up money to fund my retirement, I could be left short of money at a stage in my life when I’m not able to work and/or my health is poor.

So how much money is enough money for my retirement? To cover the most expensive case scenario of living for several more decades and/or needing full time residential care, probably more money than I’ll ever have.

With this realisation, I could react in different ways. Think, why bother when I’ll never have enough money anyway, so why not live for today, or become totally focused on earning more, spending less and saving more towards retirement. I could also resolve to live on less during retirement, taking the view that an index linked annual income of £11,400 will be sufficient during retirement.

I plan to tread the middle ground. Enjoy the present, but save any extra cash that I earn towards retirement.