Want to save £500k by 55? This is how you could do it

Many of us dream about making a million from stocks and shares. But the reality is that £1m is a tough target. It’s also more than many of us really need to retire.

Today, I want to explain why a £500k savings fund is surprisingly easy to achieve, and could enable you to retire in comfort.

How much to save each month?

Financial planners use standard formulas to calculate how much you need to save to reach your retirement goals. I’ve used these techniques to work out how much you’d need to save at different ages to build a £500k retirement pot in time for your 55th birthday.

I’ve based my calculations on the UK stock market’s long-term average annual return, which is about 8%. I’ve also assumed that the cash will be invested each month into a low-cost FTSE 100 tracker fund within a tax-free ISA or SIPP account.

It’s obvious that saving gets much tougher as you get older. Saving £500k in just 10 years requires high earning power and tough discipline on spending.

On the other hand, saving £500k over 20-30 years looks more manageable, especially if you’re sharing the burden with a partner.

Profit from this little-known secret

The figures in my table show the amazing power of ‘compounding’. This is what happens when interest — or dividend income — is reinvested into your savings each year. Each year, you earn interest on all of the previous years’ interest payments.

As the years roll by, the extra income you get from compounding snowballs into a ‘free’ extra source of income. This boosts your investing returns at no cost or risk to yourself.

For this reason, I strongly believe you should start saving for retirement as early as possible. For example, if you put just £25 into a tracker fund each month, my sums show that after 35 years you could have a fund worth £71,717.

What can you get for £500k?

At age 55, you won’t be entitled to the State Pension for at least 10 years. But you will be old enough to buy an annuity, if you choose.

I’ve used the latest best-buy annuity rates from fund platform Hargreaves Lansdown to calculate some example incomes at different ages. These figures are based on rates for a level, single life annuity.

The downside of an annuity is that in exchange for a secure income, you hand over your savings. As you can see from the numbers in the right-hand column, buying an annuity when you’re younger provides poor rates of return.

Personally, I wouldn’t buy an annuity at 55. If I had £500k to buy a retirement income, I’d keep the cash in a FTSE 100 tracker fund and choose “distribution units”. This means the dividend income from all the companies in the index would be automatically paid out to me, probably twice a year.

The FTSE 100 currently offers a dividend yield of 4.4%, matching the income from an annuity for a 55 year-old. Although dividends are never guarantees, history suggests that this approach would provide an income that keeps pace with inflation.