How to work out what pension pot you need

We show you how to estimate the pot of money you'll need in order to retire comfortably.

I'm going to show you how to use your target retirement income to work out the retirement pot you need to save. (Bit of a tongue-twister, that.)

Typically, people have no target pot, or they rely on industry estimates, or worse still they have no target whatsoever. Here's a more personalised approach.

1. Understanding annuities

When most people retire they use their pension pots to buy annuities, which is a pension income for the rest of your life. The bigger the pot, the bigger your monthly pension.

You really need to understand annuities before you can read any further, because there is some unavoidable jargon coming up.

To get a simple explanation, have a read of How to buy the right annuity. Make sure you take in what factors can affect the size of your annuity, such as your gender and whether you smoke. You should also ensure you understand terminology such as 'level annuity', 'joint-life' and 'guarantee periods'.

2. Compare annuities

Next you need to look at annuity rates, which you can do using the Financial Services Authority's comparison tables. These tables only include a small number of annuity providers, but it's good enough for our purposes.

Firstly...

1. If you've left your pension planning to the eleventh hour, find out how to catch up quick.

   Go to the FSA's 'Compare Annuities' section.
2. You'll be asked a number of questions, ranging from what age you plan to retire to whether you're a smoker. Fill these in as truthfully as possible.
3. One of the questions asks what pension pot you have. As you are trying to work out what pension pot you'll need, you can't answer that question yet. So...

For mathematicians

There are two ways to go about finding the answer. The first way is for the mathematicians among you, who will be able to work it out quickly enough by typing, say, £100,000 in and getting a set of results, from which you'll be able to work out the pension pot you need.

(Bear in mind that the size of pot you enter can also affect the annuity rate you get, but this method should be accurate enough for this exercise.)

For non-mathematicians

For non-mathematicians, I suggest a trial-and-error approach.

1. Fill in the FSA's questions. In the pension pot question, type in, say, twenty times the income you need. (In my case it's £49,000 x 20 = £980,000.)
2. You'll then get a table displaying several annuity providers' rates. The figures you see are monthly income rates. Study the table for the highest paying annuity of the type you want, i.e. level, rising by 3% per year, or rising by RPI (the Retail Prices Index - inflation).
4. Multiply that figure by 12 to get the annual income.
6. If the annual income figure is higher or lower than your target, go back to the first page of questions and change the answer appropriately. Use your best guess.

7. Related blog post

   

   • Bob Bullivant writes:

     Why thinking short-term can boost your pension!

     When it comes to buying annuities, many of us are ignorant of the potential benefits of going with a short-term annuity.

     Read this post
   Keep doing this until you have an answer that's pretty close to the annual income you need.

3. Problems

There is a problem with this exercise, which is that it is based on today's annuity rates. But you're not retiring today, are you? Annuities and annuity rates will change as time goes by, so that perhaps they'll be vastly different when you finally burn your ties or...whatever it is that women burn when they stop work.

To manage this problem, I suggest you re-visit this whole exercise from the start once a year. By doing this, you can see how your expectations for retirement may have changed, and you can make sure you're still on track.

From year to year, you may find that you need to increase your retirement savings a little, or that you can even decrease them.

I believe that this is far better than having no target, or no clue as to what size retirement pot to aim for.

This is a lovemoney.com classic article, originally published in June 2007 and updated.

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