DIY Retirement Stage 2 - How to calculate how much money you need to retire

How to calculate how much money you need to retire...

For 70% of your lifetime you work and save to build your assets in order to retire and enjoy life. However, the 70/30 split isn’t set in stone meaning there is no finish line for work or your career. As a financial advisor who mainly deals with pensions and the later percentile, it does unsettle me that there are those who try to retire without the knowledge or seeking answers to educate themselves. That’s the whole point of these articles, to give everyone the tools and information to live their best retirement possible.

Side note: in this article I’m only really talking about defined contribution style pensions (the common one), these are essentially pots of money. For the other type of pension, final salary scheme or AKA defined benefit, everything changes. Things are slightly more complicated with final salary schemes, yet they are actually easier to plan with due to their restrictions.

A misconception I should clarify before we continue is, the age at which you are allowed to retire. In the UK we do have a state pension, but it really isn’t enough to live on and it start until we are around. The misconception is that the state pension has installed a false belief in the UK that you cannot retire until the state pension kicks in, THIS IS SIMPLY NOT TRUE!

FACT: You can stop work the minute you have enough money to live on in retirement

Over the next few paragraphs, I’m going to try and explain what sort of things should be going through your mind and how to calculate the amount you’re going to need for you to be able to retire when you want to.

It is becoming common in the UK for people to retire gradually and slowly ‘phase’ out their income from employment. The less you need to draw on your pension, the higher you can expect your standard of living in full retirement. It will also allow you to have large expenditure while you are fit and healthy in early retirement and then cut back in the later stages.

Unfortunately, there isn’t an exact format that tells you how much is enough. To work out roughly how much you are going to need to have for retirement you first have to decide a few things:

1.      Age you want to stop work

2.      Phased retirement or a full and immediate retirement.

3.      Age you expect to live to – office of national statistics can help for mortality rates or for simplification you could plan to age 100.

4.      Whether you want to vary your income in retirement for each of the different stages (early retirement holidays – late retirement indoors watching TV)

5.      Are you willing to take investment risk and in turn risk your potential future income?

6.      What your life would look like if you lost some of your expected funds due to market volatility

7.      Annual essential expenditure requirements

8.      Do you want your income guaranteed?

9.      Where you want any leftover money to go

10.  Your state pension expectation (I explain this later on in a separate article)

Now the following are to get you thinking about expenditure a little more…

-         Imagine you have all the money you need, how would you live your life

-         If you found out, you only had 10 years to live how would you change your life

-         You have just found out you have 24 hours to live, what are your regrets

Once you know the answers to these questions you can then make a start on figuring out how much you’re going to need as a capital sum to be able to stop work at the age YOU want to.

By thinking about the points above you’ll be in a much better position to be able to start to plan your accrual (building/ pre-retirement) phase as you will actually have a target number. You will also be able to identify shortfalls in the pot if you plan to retire imminently.

To aid you, an example of how you could calculate the amount needed is below.

John and Betty Smith want to fully retire at the same time when they are both 60, At the moment they are 48 years old, so they have 12 years in accrual (building) phase left. They expect to live to age 100 so also have 40 years’ worth of income needed.

The couple fully redeem their mortgage at 55 so their essential expenditure will only be £20,000 per year after then.

They want to spend the first 15 years of retirement spending £15,000 per year on holidays, having fun and their grandchildren which will reduce to £6,000 after age 75 until they are age 100.

They would also like to give their 4 children £5,000 each on their death at least.

They are both happy to take risk and don’t mind if the worst happens not giving any inheritance or gifts.

They don’t however want to use their home to fund their retirement.

They will both have full new state pension when they hit 68. Therefore, the couple will receive a joint income of £18,220 per year from 68. (Once in payment this will grow in line with inflation annually under the ‘triple lock’ so we will take this off the number at the end, before adjusting for inflation)

N.B It is likely that the State pension will not kick in at 68 for the couple even though current legislation indicates it will, this is something you should take into account and act accordingly as and when announcements are made. As we know from previous increases there can be little to no warning for this, so try not to rely heavily on the State pension for your forecasting. The way in which state pension increases (triple lock) is also being reviewed under changes from Covid-19 again you must take this into account.

The quantitative calculation looks like this:

40 years at £20,000 per year for essential spend - £800,000

15 years of an extra £15,000 per year - £225,000

25 years of £6,000 per year - £150,000

£20,000 in their estate on death as gifts.

Total - £1,195,000

Less the state pension of £583,000. =

A capital sum requirement of £612,000

Now something to really take note of is that number isn’t considering any growth or inflation. Which you will definitely need to factor in.

This is very rough, it doesn’t as I mentioned take inflation into account, nor does it include interest and compound interest, or the effect withdrawals have. Also, if you went down the route of an annuity (I will cover this in a later article) the annual figure would be more important than the lump sum.

But what this gives you is a basic, realistic and quantified (numerical) starting point which you can then base your financial plan on. Financial plans should always be fluid and although this is the starting point or initial goal, that doesn’t necessarily mean that it’s perfect and that you should count it as gospel.

N.B – John and Betty are well off, they have large expenses in retirement because they can afford it, you can adjust the example to bring it more in line with your own expectations in this blank calculation here:

  1. (Your anticipated committed expenditure annually X How many years you plan to be retired)?


2. (Fun money required annually X How many years Fun money needed)


3. (Any expenditure on top of committed in later life X How many years its required)


4. Gifts you want to make or one-off expenditure


5. State pension forecasted

Possibly include Inflation and return on investment.

Hopefully, this article goes some way to explain the calculation you can do yourself, this is just one very simple way you could try, there are many ways of ‘skinning the cat’ but by having a numerical goal you are then at least on your way.

As a financial planner we go much more in depth, analysing the goal in much greater detail and much more accurately.

Next week I will cover tax and everything you need to know about UK tax affairs. Please comment and share this article if you think it was worthwhile and want others to benefit, and again, thanks for reading.