Pension savings: how much income do you really need in retirement?

A relatively comfortable retirement may not cost as much as you think.

It’s not uncommon to hear warnings about how ill-prepared we Brits are for retirement.

Indeed, a study from Wealth at Work revealed almost 40% of employees believe rising living costs mean they’ll never be able to retire.

And while we all must make the effort to squirrel away cash as and when we can, it can be all too easy to get discouraged about the results.

Looking at a private pension pot which is only forecast to deliver a £10,000 annual income is not exactly going to conjure mental images of a comfortable retirement.

However, the reality is that you may not need as much in retirement as you initially fear.

The tax situation

Tax is always an important consideration no matter what stage of life you’re in, but it’s particularly true once you come to retirement.

First of all, it’s worth remembering that you don’t pay National Insurance on any of your pension income. As a result, more of your gross income will be making its way into your pockets, rather than those of the taxman, from the off.

On Income Tax, some people find that they drop down a band once they give up work, for example from being a higher-rate taxpayer to a basic-rate taxpayer.

However, it’s worth remembering that the way you access your pension cash will have a knock-on effect on your tax outlay.

Take out too much from your pot in one go for example and you may end up in a higher Income Tax band, meaning you have to pay more to the taxman than if you paced out those drawdowns a little more.

Spending is falling

Another thing to consider here is that your costs in retirement are likely to look rather different to your current outgoings.

Chances are the mortgage will be paid off (or at least close to it), while you’re unlikely to be spending quite as much on the kids once they have reached adulthood and moved out.

Similarly, you won’t be shelling out just to get to work every day, or having to worry about the additional costs that come from being employed, whether that’s buying lunch, purchasing work clothes, or whatever else.

While your overall salary may be far higher during your working life than retirement, your actual disposable income may work out pretty similarly.

Wealth at Work, a financial education firm, calculated that in some cases people may find that they have essentially the same disposable income in retirement after giving up work even though their gross income has halved once they’ve hit retirement, though obviously, this will depend enormously on what your outgoings are like at the moment and how they may change in the future.

Don’t overlook the State Pension

The State Pension will also play a significant role in our incomes in retirement.

We don’t have a crystal ball, so we can’t say precisely how much it will be worth by the time you finish work ‒ or rather, become eligible for it. 

Similarly, while it has benefitted hugely in recent years from the ‘triple lock’ which ensures it more than keeps pace with inflation, future rises may not be so generous given warnings about just how much the State Pension is costing the nation’s finances.

How much do I need to save?

A moderate retirement income is £25,000 per year for a single person, according to the latest Savings and Resilience Barometer from Hargreaves Lansdown. 

This rises to £36,480 for a couple. 

So, how much will you need to put away each month to hit your target?

Inevitably there are some fundamental factors to take into account.

For example, it’s unquestionably the case that the sooner you start your pension ‒ even if only saving modest amounts ‒ the better off you’ll be.

The longer that money is invested, the harder it is working to generate a return for you to enjoy in retirement.

Similarly, exactly how it is invested will make a difference.

Going for stocks and shares is a popular choice, but going for a managed fund ‒ where a fund manager actively chooses precisely which companies to invest in ‒ can lead you to outperform the market, or sharply underperform. 

Throw in charges that can eat away at those returns and your choice of investments really will be crucial to your eventual pension pot.

Using the PensionBee calculator, here’s how much you would need to save each month depending on when you start your pension, with a target retirement age of 66 and income of £25,000 (including the State Pension).

It’s also important to note that while these calculations include the State Pension, they don’t include any contributions from your employer.

However, with workplace pensions now firmly established, millions of employees up and down the country are seeing their contributions benefitting from a healthy top-up from their bosses.

As a result, if you’re enrolled in your workplace scheme, you’ll be able to trim those figures above and still end up with £20,000 a year to play with when you jack in the job.

Every penny helps

While it’s true that you might not need quite as much as you feared to cover your costs in retirement, you mustn’t treat that as a reason to trim back on your contributions.

A lot can change between now and retirement, and every penny you save will help when it comes to your standard of living once you give up work.

Put it this way ‒ you don’t get too many people in old age who wish they’d saved less for their twilight years.

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