How much pension pot do I need to retire at 55?
You'd need at least an estimated £650,000 pension pot to retire at the age of 55. But as well as a good pension pot, you also need a good retirement plan. Here's how you might set about creating both.
There’s an old joke: ‘Jumping from a plane is easy; the hard part is hitting the ground.’ Similarly, choosing to stop work is something you can do at any age; what’s difficult is supporting yourself afterwards.
Anyone with a pension pot can access it however they wish from the age of 55. However, ‘can’ does not mean ‘should’. It’s usually good practice to preserve your pension pot for as long as possible before cashing in any of it, since this will be your main income in retirement. For most people, therefore, retirement will usually come in their mid-60s.
But suppose you did want early retirement at 55? How much would you need to save, and how achievable is it? Here are some of the things you would need to think about - with the help of a financial adviser.
Planning for retirement at 55: start with what you know
Although you can’t predict the future, there are some things you can estimate now with reasonable certainty. Start by asking yourself the following questions:
How much retirement income will I need?
A popular way to estimate this figure is the ’70 percent rule’, which states you will need 70 percent of your working income to maintain the lifestyle you want in retirement. So if you retire on a salary of £50,000 you would be looking at achieving an income of around £35,000. For some people 70 per cent may be generous and they would be comfortable living on less. Conversely, others may struggle.
How might my income needs change over time?
This is another key point to consider. Early in your retirement you may want to spend more, enjoying your freedom, travelling and treating yourself. Later on you may settle down and begin to spend less – but later still there may be a need for expensive long-term care. These changing requirements may influence how you decide to take your pension.
Will I have other sources of income during retirement?
Your pension may not be your only source of funds. Other assets may include:
savings
investments
properties (e.g. to let)
spare rooms in your home to rent to lodgers
working part-time
freelancing
running your own business from home
Work out which of these may apply to you, and factor them in to your overall annual income.
Can I work part-time in retirement?
You can work as much as you like after starting to take your pension - even full-time, if you wish. Legally there is no such thing as 'retirement age', and no employer can force you to retire unless it can be proven you are no longer capable of doing the work.
What you do have to bear in mind is your income tax. Pensioners are subject to the same income tax rules as everyone else, so if your income is above the personal allowance you will pay tax on it. Earning a salary may therefore eat into your pension income, thus removing some of the benefits of being a wage-earner.
How much will my state pension be?
You should also eventually begin to receive the state pension, assuming you qualify for it. State pension age is currently 65 for most people and is expected to be 68 by 2044. Currently the maximum state pension pays around £8,767 per year, so you can factor this into your long-term plan (i.e. you may not need to take as much from your private pension once you start to receive the state pension).
You'll only receive the maximum state pension if you've paid 35 or more years worth of National Insurance contributions. The good news is that the state pension is triple-locked at present, which means it will always at least keep pace with inflation (unless a future government changes this).
Which of my costs are fixed?
Think about which of your regular expenses are essential and unlikely to reduce much in later life. Remember that things like food bills, utility bills and running a car will rise with inflation. You may also have to pay more for things like dental care in later life, or home modifications if you become less mobile. Conversely, other regular costs (such as mortgage repayments) may reduce or disappear. Calculate your fixed costs when deciding how much income you'll need.
Now think about what you don’t know
Certainty is impossible in retirement planning, but you can identify the blind spots in your knowledge and plan around them. Your plan will need to account for the following unknowns:
Pensions and inflation: how much will prices rise?
What will inflation do to the real value of your pension pot? In some ways this is one of the ‘known’ factors, as inflation of some sort is virtually inevitable. In the past 25 years, purchasing power has almost halved – meaning that £1 in 2018 can buy only as much as 50 pence could in 1993. Retiring at 55 might easily result in a retirement of 25 years, or considerably longer, so you’d need to factor in how much your spending power would reduce in that time (and also, of course, between now and the day you retire).
Some investments, such as inflation-linked bonds, are specifically designed to protect against inflation, but consult a financial adviser before exploring any of these.
Will I prefer an annuity or drawdown?
An annuity is a guaranteed income for life. The amount is usually fixed, though you can have one that rises to help beat inflation. The advantage is that it can never run out, no matter how long you live. The disadvantages are that your annual income may not be very much, you may have to live a long time to get full value from it, and you can't vary your income. You also can't leave an annuity to someone else (unless it's set up to cover your spouse too).
A drawdown scheme is very different. Your pension pot remains invested in the stock market, and you draw on it as needed. The advantages are that you can take varying amounts, and if there is money left when you die, you can leave it to your dependants. The disadvantages are that the pension pot depends on stock market performance, so can lose value steeply at times - and running out of money is a real risk.
What will annuity rates be when I retire?
You may decide to buy an annuity (a guaranteed income for life) either when you retire or at some later date. Annuity rates are poor at present, but may change in future. You may also be able to get an enhanced (more generous) annuity if your health deteriorates later on.
How long will I live?
These days, living to the age of 90 and over is not uncommon. If you retire at 55, that would mean a 35 year retirement. Would your pension pot be enough to sustain you over that time? Also the inflation issue (see above) becomes even more pressing – prices in 2018 are triple those in 1983.
How will the stock market perform?
If you keep your pension pot invested and make regular withdrawals (i.e. you have a drawdown scheme), it remains exposed to risk on the stock market, and its value can go up and down. Over time the market generally increases in value, but there are inevitably periods of loss, and sometimes big crashes. Withdrawing money during one of these dips can erode your pot’s value much more quickly.
The power of compound interest
Another big unknown factor is how the investments in your pension fund will perform during the saving-up period ('accumulation'). We've assumed a steady rate of 4 per cent in the calculations below, but it may be higher or lower. You can help your pension along by ensuring it is invested in the best pension fund for you - most workplace pensions start off in the default fund, which may not be ideal.