Running out of cash in retirement is a frightening prospect. Unfortunately, this can and does happen to retirees on a disappointingly regular basis.
However, there are several moves you can make today day to ensure that you do not fall into this trap later in life.
It might seem obvious, but the best way to protect yourself against financial hardship in retirement is to start saving and build your private pension.
From 6 April, the State Pension will rise to £175.20 a week, or to £9,110.40 a year. That’s enough to provide a basic income in retirement, although many retirees believe they need at least £20,000 a year in income to retire comfortably.
The best way to build this pot is to open a Self-Invested Personal Pension. Anyone can contribute to a SIPP, and the sooner you start saving, the better, even if it’s only a few pounds a week.
Any SIPP contributions are entitled to tax relief at your marginal tax rate, which is 20% for basic rate taxpayers. So, for every £8 you contribute, the government will add £2 on top.
When you’ve opened a SIPP and started saving, the next step is to invest your money. With interest rates where they are today, investing is the best way to grow your wealth over the long term.
Indeed, over the past 35 years, the FTSE 250 has produced an annualised return of 12%. That’s more than 10 times higher than the average rate of interest on offer from most savings accounts today.
Other investment options are also available. The FTSE 100, for example, has returned around 7% per annum since inception. SIPP investors can even own international stocks and funds.
Stocks have the potential to produce impressive returns over the long run. However, these are only really suitable if you have an investment horizon of 10 years or more.
While it is possible to predict what the future holds for stocks over the next few decades, it is impossible to say where the market will go in the next 5 to 10 years.
As a result, if you plan to retire sooner, a bond fund might be more suitable. It is still possible to get yields of 2% to 3% from these funds. Once again, that’s still far above the best rate cash investors would receive.
Finally, one of the easiest ways to make sure you don’t run out of money in retirement is to set up a savings plan.
One of the biggest mistakes future retirees can make is not saving enough to afford the lifestyle they want. The best way around this is to work out your desired annual income in retirement, and then work backwards to calculate how much money is required to hit this target.
A good strategy to use is the multiply by 25 rule. Using this rule, you take your desired annual income in retirement, for example, £25,000 a year, and then multiply it by 25. This gives a total of £625,000.
It would take 35 years of saving £100 a month to hit this target, assuming the money is invested in an FTSE 250 tracker fund that returns 12% per annum.
With this road map in place, it should be possible to plan ahead and make sure you avoid running out of cash in retirement.
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Rupert Hargreaves has no position in any of the shares 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.