How much is enough?
It’s a key question when it comes to planning your retirement or setting a financial goal, and you will find it hard to get a straight answer.
You need to take into account your current and desired lifestyle, current age, risk tolerance, investment options, life expectancy and post-retirement bucket list. Working through these element is a cornerstone of my approach with coaching clients.
Many people still think of £1m as a big pot of money or a benchmark number to hit, perhaps thinking this would be more than enough to last them throughout their golden years. But can you really live off £1m in retirement?
How much would you get in interest?
Your first thought might be that you could live off the interest by putting your £1m into a straightforward savings account at a a bank or building society. The best rates available for this size of cash are currently around 2%, which will generate £20,000 before tax. Many rates are 1% so you'll get an even more depressing £10k interest per year.
Given interest rates have started to move up in the UK you might be hoping that it won't be long before bank rates are more attractive - think again. The latest forecasts predict only another 0.5% increase between now and 2020. So basing your retirement on living off the interest is a very risky option without any guarantees of what your pension income will be each year.
Additionally, if you take out the interest every year you can’t take advantage of compound interest and your £1m will never grow. Inflation (currently at c.3% in the UK) will eat away at your measly fixed interest of £10k-20k, reducing your spending power every year which eventually might not even cover your living costs.
Time to get stuck into the capital
So if living off the interest isn't going to work, it's time to start spending the capital. But how much can you safely spend and not run out of money?
Many financial industry experts recommend the 4% rule. That means, in order for your £1m pension fund to stand a chance of carrying you through your retirement, you should not withdraw more than 4% per annum. Ideally you would also invest the pot of money to try and grow at least at the rate of inflation, giving you a chance of maintaining your living standard going forward.
So the 4% rule would give you £40,000 to start with, and depending on how you invested the pot you would get a diminishing amount per year (it's 4% of the annual pot, not 4% of the initial pot).
Some finance gurus are now advocating reducing the 4% to 3% to reflect expected lower stock market investment returns going forward. So your £40k just reduced to £30k.
Although £30-40k is now beginning to resemble more of a decent sized retirement income, you still have to consider how it compares to your current lifestyle and whether its enough to realistically live your retirement free from financial worries.
This is a hot topic at the moment as individuals with a defined contribution plan no longer have to buy an annuity following the pension reforms. Many people are opting to take the whole amount as a lump sum and have the flexibility of taking as much money as needed. But this could be a risky game without professional advice, as ideally you should keep as much invested as possible, and you need to monitor the 'drawdown' amount very careful.
Normally I'm a big advocate of 'Do-It-Yourself' investing. But when it comes to quitting work (at any age) and living off your financial assets I think it's wise to get some expert advice.
Will an annuity get me more?
The traditional pension route was to save up as big a pot of money during your working life and then buy an annuity with it once you retire. The benefit is a guaranteed regular income for the rest of your life, sometimes also linked to inflation, however rate's vary significantly from provider to provider.
So how much can you expect from £1m?
If you buy an annuity offering an inflation-linked, lifetime guaranteed income that will provide around two-thirds of the value to your spouse or partner after your death, you can expect an annual income of around £21k.
If you are used to earning £75k plus per annum, this will be a significant cut to your earnings upon retirement.
Is it enough?
So pure bank interest will possibly give c£10-20k, sensible spending of the capital gives you c£30-40k, and an annuity gives c£21k.
If you are a higher income earner and used to a certain standard of living, and want to maintain that lifestyle in retirement, a £1m retirement fund isn't going to get you there.
What are your options for a better retirement?
The best thing you can do right now is follow the process I take my clients through:
- Start working out what kind of lifestyle you want in retirement: if this is 25 years away if can be quite vague, if it's 5 years away it needs to be very detailed
- Do an inventory of what you have now: cash and savings, pension pots, equity in property, investment accounts
- Forecast the future: estimate the future value of assets in step 2 based on your savings rate, and estimated investment returns. Excel is your best friend for this and I've created a sheet to help you do this.
- Assess your retirement gap and work out how much you need to put away per month to close it.
Of course there are lots of strategies and tactics you can use in step 4, but I think most people overthink this element, get bogged down in the detail, and forget to do steps 1-3.
Start working on your lifestyle finance plan as early as possible (HINT: if you don't have one then start TODAY) to give yourself the best chance of achieving the kind of financial freedom you crave during your working life.
PS: If you are a competent personal finance DIYer then do the above ASAP. If you want help some help working through the concepts and details then consider my 4 week coaching course - I'm not currently taking on new clients but register your interest here and I'll send you more details when a slot opens up.