How To Retire In Luxury
Read part four of our three-part pensions series! This one shows you how to work out what you need to save each month to have a comfortable retirement.
This is the fourth part in a three-part series (don't ask) that will help you to work out what size pension pot you need to retire comfortably, and how much you need to save to get there.The Four-Step Guide To A Comfortable Retirement: Part FourThis is the fourth part in my three-part series*. For this final part I'm going to show you how to work out what you need to save in order to fund that nice, comfortable retirement you've been planning using parts one, two and three.After reading the earlier parts, you should now know what size retirement pot you're aiming for. Now you need to work out what you need to be saving to achieve it.1. Look at your current investmentsFirstly, you need to re-visit The Fool's compound interest calculator 1.Let's assume that I have £25,000 of investments which I don't intend to use until I retire, and another £15,000 already in my existing pensions. Total £40,000.If you remember, I've been working on the (hypothetical!) premise that I'm retiring in 40 years. Now let's say I want a safety barrier of five years, i.e. I want to aim to get to my full retirement pot in 35 years, in case the stock market goes on a slump in the last few years before I stop work. Here's what I do. Firstly I enter into the calculator:FieldTypeHow much will you invest each month?Left blankFor how many years?35Is there an initial lump sum?40000What is your expected rate of return?7I typed 35 years, with a pot of £40,000 and an average annual investment growth of 7%. The answer I got was £427,000. So I'm short of my £1,140,000 target pot by a hefty £713,000.Now it's your turn. If you have investments you want to use for your retirement pot, type in your own figures assuming, for the moment, a 7% return.2. Now work out what you need to contribute each monthDon't close the compound interest calculator just yet. You now need it to work out how much you need to contribute to your pension each month to reach your target.This is where we use trial and error, just like in part three. To do this, you keep all the details the same as in 2 (above), but in the top field 'How much will you invest each month?' you enter a monthly amount.I started by entering £150, so my calculator now looks like this:FieldTypeHow much will you invest each month?150For how many years?35Is there an initial lump sum?40000What is your expected rate of return?7The return I got here was £685,000. This is still way short of my £1.14m target. I then changed it to £400, which was still a little low. Eventually, I found that £415pm was close enough with a result of £1,141,000.So I would need to contribute £415pm in order to get my target pension pot, assuming that it grows at 7% per year.3. Government and employer contributionsRemember that the Government tops up your contributions and that your employer might contribute too. If I assume that the Government will give me 20% tax relief in forty years (they currently give 22% to basic-rate earners, but this will go down to 20% from next April), and assuming The Motley Fool is generous enough to double my contributions, this means I need only contribute £184pm!4. Other savings and lump sumsYou may also have savings or lump sums that you are sure will come your way, perhaps through an inheritance. You should take all these things into account in your above calculations if you want to add them to your retirement pot.5. About my assumptionsAgain, there are many assumptions here. Probably the main one is that I'm assuming that my investments will rise at 7% on average. I think 7% is achievable (indeed, perhaps quite conservative), but you should consider how drastically different your pot will be if the average return is just slightly lower. At 6%, my pot would grow to just £880,000, which is £260,000 (23%) short of my target!In fact, with a 6% return I'd need to increase my contributions from £184 to £269pm in order to reach my target pot.6. Scared about the amount you need to save? There may be some hope!One thing I haven't factored in here is the state pension. I know that many of our clever board users would think it unwise to assume we'll get anything from the Government. However, I must admit to being a bit of a Foolish heretic in that I think the odds are we will continue to receive an equivalent state pension over the next few decades. But, in truth, my belief is a punt; no one knows what the situation will be in a decade or three.It's up to you whether you factor in the state pension, but you should consider doing so if the target you've found yourself with after going through the above exercise is unrealistic.At present, everyone who has worked most of their lives is entitled to a full annual state pension of £4,540 per year. If you have missed, or will miss, many years of work, you might not qualify for the state pension, or you might receive a smaller amount. Read Boosting A Woman's State Pension to learn more. (It's useful for men too!)To get new figures with the state pension included, you'll need to go back to part one and deduct from your target pension the state pension amount. For most of us this will be £4,540. Then you need to re-do this whole exercise.For example, if I was to re-do this from part one, going through all the steps again and deducting the full state pension, I'd need:Part one: £15,000 - £4,540 = £10,460 per year.Part two: £34,000 per year after inflation (at 3% inflation for 40 years)Part three: An £800,000 pension potPart four: A much reduced monthly saving requirement of £98 per month (down from £184).I hope you have found this series useful. If you have any questions or would like help with your calculations, ask the helpful Fools on our Pensions - Practical Problems discussion board.You've been reading part four!Go back to part threeGo back to the start*Four for the price of three! Now there's a Foolish bargain. It's better than the out-takes on a Jackie Chan DVD.> Want to know more about pensions? Read our guide to pensions and annuities: Fool's Guide To Pensions