There is rarely a straightforward answer to the question of “How much money do I need to retire comfortably?" Everyone's retirement needs are different and can change over time.
The good news is there are clear steps you can take to set yourself up for a financially stable retirement.
For high-net-worth individuals (HNWIs) looking to maintain a high standard of living after they stop working, it's vital to take an in-depth look at their full retirement picture.
“Many of our clients are used to receiving a significant income every year and are often able to spend money without thinking too deeply about it," says Lucy Day, associate director, Relationship Management for RBC Wealth Management in the British Isles. “When we tell them how much they might need to grow their savings pot in order to continue that lifestyle throughout retirement, it can come as a shock."
For example, RBC Wealth Management calculates that someone who is looking to fund a 30-year retirement, spending £250,000 a year, with inflation at 3 percent, could require up to £11.9 million in their retirement "pot." Now that's the extreme scenario based on a 0-percent rate of return. If applying a 5-percent rate of return (net fees and taxes), the required amount falls to £5.8 million.
While these are only illustrations, at the very least they show that a consistent return on investment (albeit, requiring a higher level of risk) significantly reduces the level of capital needed. They also reinforce how critical it is to have appropriate planning in place – and to start the process as early as possible.
So, how exactly can you calculate the total you'll need to fund the retirement you want? Here we look at six key steps that can get you on the road to realising your goals.
1. Determine what you expect your expenditure to be
In order to calculate the size of your retirement pot, you need to have a reasonable idea of how much you want to spend each year. And this means carefully scrutinising – and questioning – your anticipated spending.
“We typically look at a client's level of expenditure and explore how they expect that to change, either up or down," explains Day. “A lot of factors can come into play. They may be paying a huge amount in school or university fees right now, for instance, but that will tail off at some point. After that, they may plan to buy property for their children or pay their grandchildren's school fees."
How people choose to spend their retirement years will also have an impact. Some may wish to travel the world extensively, which could involve significant spending on holidays over a period of 10 or 20 years. Whereas others may want to live more simply and enjoy hobbies closer to home.
“It's also not uncommon for clients to focus on retaining the value of their assets for the next generation," says Day. “So while they want to be able to live comfortably, they don't want to considerably reduce the net value of their estate because they want to be able to pass that on."
By examining what you currently spend and how you expect to live in retirement, you can begin to understand the amount of income you'll require.
2. Factor in contingencies
If there's one phrase befitting of planning for retirement, it's "expect the unexpected." It's therefore important to look at certain contingencies and factor those into your calculations.
For instance, your family circumstances may change – more grandchildren than expected may come along or a child may wish to relocate abroad. On the other hand, you or someone in your family may need long-term health care. There may also be external factors, such as market volatility or rising inflation – both of which can erode the value of your investments or savings.
“Because we are considering unpredictable things here, it's not an exact science," says Nick Ritchie, senior director, Wealth Planning for RBC Wealth Management in the British Isles. “This is where scenario planning and cashflow modelling play a really important role."
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3. Calculate the size of your required retirement pot using cash flow modelling
According to Ritchie, it's vital to look at several scenarios based on your anticipated expenditure. “We tend to show clients a couple of scenarios," he explains. “So, we'd say, 'This is your spending requirement – and this is how much you would need in your retirement pot in order to sustain that requirement over a typical lifetime. And here's how that varies depending on different rates of inflation, life expectancies and rates of return,' this can then inform the level of risk someone is willing to take in pursuit of their retirement pot."
Those willing to take lower levels of risk will typically have to put more aside during their working life to achieve their retirement goals. But what this type of cash flow modelling does is show a range of options that essentially cover best- and worst-case scenarios. "It gives you a much better sense of the number you'll need for the long term. It will never be exactly right, but it makes the often intangible concept of 'how much is enough,' become far more real" says Ritchie.
4. Put a retirement plan into action
Looking at these scenarios can be a relief for some people, as they may learn they are closer than expected to their required amount. For others, however, it may come as a wake-up call that they need to take decisive action. Either way, a clear plan needs to be put in place.
“There are two parts to this," says Ritchie. “One is getting the right structures in place to grow the wealth efficiently, for example by taking advantage of basic ISA and pension allowances and potentially more sophisticated alternative retirement strategies. Then when it comes to accessing funds it's also really important to withdraw capital and income in the most efficient way." This may mean putting money into cash reserves to draw from in the first few years after retirement, then using a combination of pension lump sum withdrawals and capital and dividend payments to maximise the use of personal allowances throughout the retirement years.
Another factor that has to be considered is how near to retirement you are. “If someone closer to retirement doesn't have the pot they had hoped for, they may decide they have to take extra risks. But that isn't something we would typically recommend if a significant portion of those funds need to be accessed in the short term," says Day.
5. Don't forget succession
For some individuals, it will be important to view their retirement planning in the context of a succession. It's possible you already have separate vehicles in place for this – for example, trusts – but there are potential tax implications from retirement planning, including from inheritance tax (IHT).
Most modern pensions sit outside of an estate for IHT, for example, so this may affect your decision over whether or not you draw on them during your retirement. It may make more sense to first spend other assets which would otherwise be exposed to inheritance tax in the event of your death. That way the value of any pensions can be preserved and passed on without a significant IHT liability.
6. Undertake regular reviews
Because circumstances can change, it's important to make sure your retirement plan is reviewed on a regular basis to ensure you remain on track.
“We always recommend reviewing retirement plans annually as a minimum," says Ritchie. “That review will involve multiple aspects, such as how any investment strategy is performing, whether you are spending more or less than before, and if that means changes need to be made."
Alternatively, that review may reveal nothing needs to be changed and everything is progressing as expected, which in itself can bring significant peace of mind.
A comprehensive and holistic approach to retirement should deliver the pot you need, ensure you are drawing it in the most cost-effective way, and enable you to take care of what matters to you most.
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