Retirement comes with some of the biggest financial decisions that we will make in our lifetimes. One of the most important factors in deciding when and how to retire is understanding how much money you will need to sustain a comfortable and fulfilled lifestyle.
It’s common for the media to report arbitrary headline figures on this topic, such as individuals needing between 50-80% of their current salary in retirement. People tend to therefore be focused on what they can get from their pensions/assets rather than considering what they actually want or will need from them first.
Determining your retirement needs however is a much more personal calculation than simply striving for an off-the-peg percentage and comes down to each individual’s circumstances and lifestyle choices.
Here is a simple framework to help you start thinking about this in a practical way.
The Pensions and Lifetime Savings Association (PLSA) recently revised their Retirement Living Standards, which are intended to help savers think clearly about the kind of lifestyle they might lead in retirement.
The standards aim to provide an indication as to the level of income that might be required in retirement based on three different categories of lifestyle: minimum, moderate and comfortable.
These are shown in the table below:
|Retirement Living Standard
|Annual Need – Single Individual
|Annual Need – Couple
|Rest of UK
|Rest of UK
|Covers all your needs, with some left over for fun
|More financial security and flexibility
|More financial freedom and some luxuries
Whilst the standards provide a simple guideline to help people get engaged with their retirement, they should be the starting point of the conversation. Retirees need to delve deeper into their own expectations of what a fulfilled retirement looks like to get an understanding of the sorts of amounts that would apply to them personally.
Determining your retirement spending
Assessing your personal spending can be a daunting task, but it is crucial to creating a realistic and reliable retirement plan. Using the following three steps, you can begin to get a better understanding of the amounts you will need.
1. Determine your essential monthly outgoings
A good place to start is by separating your ‘needs’ from your ‘wants’. List out your current regular monthly bills, including things like council tax, utilities, food, travel and motoring costs, insurance premiums, home maintenance, clothing and medical and dental costs.
You should also consider how each item might change when you enter retirement. For example, you would expect your commuting costs to reduce once you stop working, your energy bills to rise from spending more time at home and you may want to replace any private medical insurance that may have been provided by your employer.
Whilst it is seemingly a straightforward exercise, this will show you the absolute minimum level of income you will need and provides a baseline amount for you to build from.
2. What does a good retirement mean to you?
Next, spend some time thinking about what a fulfilled retirement means to you. Maybe you will be spending more time on certain hobbies and interests, eating out more often, taking day trips, seeing friends and family or planning to travel more frequently.
Whatever your ideal day-to-day retirement lifestyle would look like, determine how much you would expect to spend on each item and how often you might expect to do the things you enjoy on a weekly, monthly or quarterly basis. This estimated figure can give you a reasonably accurate basis to work from and refine as you get closer to retirement.
Ensure you include any memberships or subscriptions that will continue and any charitable donations you would like to make, as well as allowing for gifts and celebrations ,such as birthdays and Christmas.
3. Consider any larger and irregular capital expenses
Whilst steps one and two can help to determine your ‘normal’ expenditure pattern, it’s important that you also consider any potential larger or irregular expenses.
This could include more expensive holidays, home improvements, gifts to children or grandchildren and the periodic replacement of vehicles. It can also be useful to draw out a timeline so that you know how much you will need and when.
Within this category you can also make allowance for any aspirational expenditure, for example, taking a once-in -a-lifetime trip or buying that motorhome you have always dreamed of.
It is also important to be aware of the potential for less welcome irregular expenses, such as a broken boiler or car repair, and advisable to set aside an accessible emergency cash reserve for when such unexpected costs arise.
Trial run your retirement
It is understandably common for future retirees to struggle when assessing what they might spend in their new lifestyle, especially if the majority of their time is currently spent at work. If this sounds like you, consider undertaking a trial run of retirement.
This involves taking time off work, without planning a trip away, to test drive the everyday activities that you think would replicate your desired lifestyle.
This can help to validate whether your expectations of life in retirement are realistic for you, which in turn can assist in determining whether your spending assumptions are reasonable.
How might your spending change?
One popular view is that the pattern of spending in retirement is ‘U-shaped’. This means that once people retire their spending is expected to be relatively high as they are still fit and healthy, before their outgoings decrease as they age and become less active. Finally, as they move towards later life, expenditure rises again due to the costs of care and support as they become more dependent and less active.
However, this view has been challenged in recent years, with research showing that, on average, spending is actually more likely to decrease steadily throughout retirement. Although spending on ‘essential’ items stays relatively stable, the reduction tends to be driven by declining spending on ‘non-essential’ items.
Creating a retirement plan
Understanding your expected expenditure once you stop working is one of the most crucial elements in creating a robust and tailored retirement plan so taking the time to assess your spending will give you greater confidence in the financial decisions you make about your future.
With the help of sophisticated lifetime cash flow modelling, our financial planners can help give you clarity and peace of mind in relation to achieving your desired retirement lifestyle.
Please get in touch today to discuss your retirement plan.