According to the Financial Conduct Authority’s Financial Lives survey of 13,000 consumers, which was published last year, around 15m UK savers have no pensions savings and, as a result, face a bleak future in retirement. The survey also showed that approximately two-fifths of those with defined contribution pensions have less than £5,000 saved and only 12% have more than £100,000.
These numbers are worrying. We need a lump sum to fall back on in retirement, and it’s a good idea to have this safety net in place even if you don’t plan on quitting the rat race anytime soon.
Luckily, creating a lifetime income pot is not hard, all it requires is a little discipline and patience.
How much do you need?
The first step in this process of saving for the future is to set a goal of how much you’ll think you need in retirement. There’s no set rule, but a rough figure of 80% of your income at the time of retirement is an excellent guide. For simplicity’s sake, I’m going to use 80% of the UK’s average wage (excluding any state pension) of approximately £27,500 for this article.
Once you know how much you need, you can work backward to find your required total pension size.
According to my figures, to receive £22,000 a year in retirement, you would need a pension pot of £403,000 in today’s money. For many of us, hitting this target is entirely possible, even though it might not seem like it straight away.
Assuming a conservative return of 8% per annum (around the same as the FTSE 100 average annual return for the past few decades), if you started saving at age 20, you’d only need to put away £160 a month to hit this goal by age 68. If you put off saving until your 30s, you’d need to put away £280 a month, which works out at around 10% of the average salary. By age 40, you need to have £530 to be able to reach the £403,000 target.
Risk and reward
The figures above are based on relatively conservative return assumptions. If you want to take more risk with your portfolio, you could hit retirement much faster. For example, over the past 10 years, the FTSE 250 has produced an average annual return of 10.5%. At this rate of return, you’d only need to save £70 a month at age 20 and £350 at 40 to hit the £403,000 high water mark. A basket of high-quality growth and income shares may also generate better returns, as my Foolish colleague Alan Oscroft explained here.
After reaching your savings goal, the next step is to plan ahead to make sure this income can last you for as long as required. Using ‘buckets’ to segregate your wealth can help with this. To maximize your wealth creation, you can place part of your wealth (income for the next three years) into a bond ‘bucket’ using these funds to buy safe income from bonds. With near-term income segregated, you can continue to earn higher returns from the equities ‘bucket’ without having to worry about market drawdowns.
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Rupert Hargreaves owns no share mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.