If we calculate how much we spend in our daily lives now, we can get a clearer picture of how much we need in retirement.
It's also useful to ensure we have full State Pension contributions, and we can sometimes use voluntary contributions to top these up.
Those with private workplace pensions should be cautious about withdrawing early and consider the full length of their retirement and how much they need per year.
Questions to ask when thinking about retirement
Before we can get a complete picture of how much money we need for our retirement, we first have to understand how long that period of our life is likely to last and how much we would expect to spend every year.
These are three important questions to ask when thinking about retirement and pension contributions:
- How long will my retirement last?
- How much income will I need during my retirement?
- What income will I have during my retirement?
Let's look more closely at these three questions more closely.
How long will my retirement last?
Understanding how long our retirement will last is one of the most important ways to help work out how much money we need to have saved before we retire.
It's helpful to look at the latest Office for National Statistics (ONS) research on life expectancy to get a clearer idea of average life spans in the UK.
Their life expectancy tables covering 2018 to 2020 show:
- Men can expect to live for around 79.0 years
- Women can expect to live for around 82.9 years
- Men aged 65 between 2018 and 2020 could expect to live another 18.5 years on average
- Women aged 65 between 2018 and 2020 could expect to live another 21.0 years on average
Life expectancy fell slightly for men compared to 2015 to 2017, with a fall of 7.0 weeks recorded. Women experienced a slight increase in life expectancy of 0.5 weeks.
These mortality tables from the ONS were the first to include deaths from coronavirus and led to a decline being seen in life expectancy for the first time since the data began to be recorded in the early 1980s.
However, these changes were slight and it still stands that a person retiring at the current State Pension age of 66 could live for more than twenty years.
Budgeting for a longer lifespan ensures a comfortable retirement rather than frequent worries about running out of money or having to live more frugally in old age.
How much income will I need during my retirement?
The income we need during our retirement depends on what sort of lifestyle we have and what overheads we have.
Many elements of our everyday life our wages pay for while we're working will still need to be accounted for during retirement. These include:
- Utility bills
- Transport costs
- Health and fitness
- Leisure activities
- New clothes
- Charitable gifts
Widespread calculations about retirement sometimes assume retirees will have paid off a mortgage and so won't have housing costs to worry about. For many older people, this won't be the case, so remember to factor rent into the equation - including any plans to downsize in retirement.
Work out roughly how much you (and your partner, if applicable) on the categories mentioned above right now. It doesn't have to be exact, but it will give a ballpark figure.
The best way to do this is to work out the average weekly and monthly costs now based on a few months of figures.
Then account for inflation at 2.6% (the average rate between 2011 and 2021) for the number of years remaining before the state pension age of 66.
Here are a few examples based on a person looking to retire in 10 years:
|Category||Monthly Costs||Annual Costs||Annual Cost Plus 10 Years of Inflation|
Note: These figures are based on the latest ONS data release published for household expenditure focused on 2020. They do not take into account the price rises in 2021/2022.
Doing these calculations for every type of expenditure you expect to carry into retirement, and then add extras such as more holidays if that's something to consider.
Remember to cut out or lower the expenses that may not be applicable in retirement such as commuting costs or domestic travel.
Let's say we come out with an average of £30,000 per year for a couple.
If we live for 20 years after retiring, we need a total pension pot of around £640,000 in total. That may seem like an extraordinary figure, but it's easier to contemplate when we break down the elements of our retirement income.
What income will I have during my retirement?
Thinking about retirement usually means we consider two income sources: the state pension and any private pension from an employer.
However, we might have other forms of retirement income:
- Rental income
- Equity release
- Non means-tested benefits
It's important only to include income we definitely know we're going to receive (rather than a speculative inheritance pot). It's better to overshoot in our estimates than to leave ourselves short during our retirement.
Let's take a closer look at the two pension options most of us have.
Retirement and the state pension
The State Pension is a crucial element of retirement income for many people, but changes over the last decade have altered the way it is calculated.
The flat rate State Pension came into force in April 2016 and replaced both the second state pension and the State Earnings Related Pension Scheme (SERPS).
Anyone who started building up contributions under the old pension system will have those contributions converted to an amount under the new system.
People who began contributing after April 2016 will pay all their contributions under the new system.
What age can I draw my State Pension?
The State Pension age has recently risen to 66 and is set to increase to 67 between 2026 and 2028.
A further increase up to 68 is expected in the 2030s, possibly between 2037 and 2039. The Government is currently looking at when to bring that change in.
Although we can draw our State Pension at 66, it doesn't mean we have to.
If we defer our State Pension, it increases by 1% for every nine weeks we defer. This works out at around 5.8% extra for every year we defer.
What is the new State Pension?
The new State Pension is a flat rate pension based solely on our National Insurance records.
For the year 2022-23, the weekly rate for the state pension is £185.15. This works out at around £740 per month and just over £9,600 per year.
For a couple, this would be £19,200 per year if both retired at the same time.
The State Pension is expected to increase by the rate of inflation each year, although this was suspended for the 2022-23 financial year due to soaring wage inflation.
However, if we take that 2.6% average inflation figure again for a person 10 years away from retirement, we could expect the total to be around £9,850 for an individual or £19,700 for a couple.
How many years of National Insurance contributions do I need to retire?
The new State Pension requires 35 qualifying years of National Insurance contributions. This is five more years than the old state pension needed.
If a retiree has fewer than 35 years of qualifying contributions, they won't receive the full amount of the State Pension.
Anyone with less than 10 years of qualifying contributions won't be eligible for any pension at all.
It's possible to pay up to six years of voluntary contributions to top up recent gaps in contributions, and this can be done up to six years after a person reaches the State Pension age.
Retirement and private pensions
As well as the State Pension, many of us will have private pension pots as part of our employment.
These can be defined benefit (DB) or defined contribution (DC) pension schemes.
Since auto-enrolment rules came into force in 2012, employers have been required to offer a pension to employees until they choose to opt out, so many people will have one or more small pension pots lying around.
We've got more detail on how to trace lost pension pots in this guide.
Defined benefit schemes
Defined benefit schemes are also called final salary schemes, and they offer a retirement income based upon a proportion of an employee's final salary.
Despite the name, a final salary scheme doesn't necessarily refer to the salary an employee is earning at the time of retirement, so it's important for employees to be clear about how much they will earn from their DB scheme in retirement.
Some DB schemes will include a cash lump sum on retirement as well as an income. This could be added to savings for use in future years.
Defined contribution schemes
Defined contribution schemes are also known as money purchase schemes, and these are far more common these days than DB schemes.
There are various different types of money purchase pension schemes that can be sponsored by employers including:
- Contracted-out money purchase schemes (COMPS)
- Contracted-in money purchase schemes (CIMPS)
- Small self-administered schemes (SSAS)
Alternatively, personal schemes may be offered to employees which employers may also contribute to. These could take the form of:
- Group personal pensions (GPPs)
- Group Stakeholder pensions (GSHPs)
- Self-invested pension plans (SIPPs)
- Group self-invested pension plans (GSIPPs)
Contributions in money purchase schemes are invested, and the administrators of the scheme will give employees options of which to invest in.
A DC pension pot's value will change over time and the final value will depend on various factors. These could include:
- How much has been paid into it the scheme
- Investment growth
- Any charges deducted from the scheme
On retirement, we can opt to receive an income only from the DC scheme or a tax-free lump sum upfront and a reduced income.
Income can be taken in several ways such as:
- Purchasing an annuity
- Income drawdown
- Scheme pension
It's worth remember employees should receive annual pension statements, allowing them to see how much money is building up.
When can I claim my private pension?
Private pensions can currently be claimed from the age of 55, which is why we often hear about unlocking our pensions early and using them to fund an early full or partial retirement.
This is set to change: by 2028 we will only be able to withdraw money from pension pots aged 57 or above. From then on, the age will remain exactly ten years below the state pension age.
Since the rules were altered about withdrawing lump sums, there have been mis-selling scandals and fraudulent pension schemes, so employees should remain vigilant when dealing with their pensions.
Those in workplace pension schemes will usually need the consent of their employer or ex-employer to take their benefits, and it can only happen if the terms of the contract allow for it.
Although a default retirement age no longer exists so we can usually retire later than the State Pension age, some industries can force retirement if the job requires physical abilities or has an age limit set by law such as the fire service.
Workplace pension arrangements can be affected by working beyond the retirement age - check the pension contract to understand how that works.
How much do I need to make from my private pension?
If we take the target figure of £30,000 income per year, we need up to £20,000 a year from a private pension scheme for an individual.
For someone living 20 years of their retirement (assuming they retire fully at state pension age), this would amount to a pension pot of £400,000.
Will my pension last through retirement?
The question most people looking at their pension plans want to know is whether their pensions will last through retirement.
Unfortunately, there's no definitive answer to this and it depends what kind of pension pots we've built up during our life and what sort of retirement plans we have.
In addition, factors such as the uncertain rate of inflation and the (albeit temporary) suspension of the triple lock for the State Pension can impact how much we can expect to receive from the Government when we retire.
It's far better to overshoot than undershoot, especially considering the employer contributions of 3% in workplace pensions and the tax relief available on private pensions to encourage saving.
Research published by Standard Life Aberdeen in 2021 found that 66% of adults retiring that year risked running out of money with a third admitting they had less than £100,000 saved in their pension pot.
Only 39% of those getting ready for retirement were very confident they were financially ready to finish working. In addition:
- 48% were planning to reduce their usual spending to support themselves in retirement
- 27% were planning to work part-time to help financially
- 21% were planning to sell their home or downsize
So, it very much depends on a person's circumstances, but the closer we get to retirement age, the more difficult it is drastically improve a pension pot.
For most of us, the general rule should be to save as much as we can early on and don't be tempted to opt out of workplace pension schemes in the hope that the State Pension will suffice.
When should I retire?
With all this in mind, at what age should we retire and when should we draw on our private pension pot?
It depends on the following factors:
- Whether we have 35 full years of National Insurance contributions to ensure we receive a full state pension
- Whether we have gaps in our National Insurance record and want to fill them
- Whether we want to defer retirement to add 5.8% to our pension every year
- How much is in our private pension pot
- How much our monthly income would be if we retired early
- Whether we have savings or other income
- What kind of lifestyle we want from our retirement
This final point is often the crux for anyone thinking about retiring early. It's easy to underestimate how much we might need in our retirement, so ask the following questions:
- How much do I need for 20 years of retirement?
- Am I willing to compromise on luxuries to retire earlier?
- Are there any ways to add to my income in retirement?
Every person and couple have different needs to consider ahead of their retirement. These questions are a good place to start but bear in mind that everyone's circumstances are different and so calculations and projections must be personalised.
Summary: plan early for retirement
The State Pension provides a good starting point for anyone trying to work out how much they will get if they retire at the State Pension age.
As this is now a flat rate, it makes estimating the amount we'll receive if we have full National Insurance contributions easier.
It also gives us an idea of how much more we'll need to live a comfortable retirement, giving us something to aim towards as we save for our later years.
Remember that workplaces are required to offer pension schemes and cannot force employees to opt out. In addition, remember there are personal pension options that self-employed people and those not in regular employment can use to help build up their pension savings.
Always check the Financial Conduct Authority (FCA) registers before investing in any pension scheme to ensure they're legitimate and never be rushed into making decisions about your pension pot - if a scheme's promises sound too good to be true, they usually are.