FOR many people, the whole point of saving for retirement is to build a pot that can generate an income big enough that they no longer need to work.
But despite this being the primary aim, it’s often difficult to know exactly how much you need to achieve it. Having a nice big number showing in your retirement account feels good, but it doesn’t mean much if you don’t know what that will translate to in retirement.
Even at younger ages, having an understanding of how much income your retirement savings will generate is sensible because it means you can tailor your contributions to build a pension pot that gives you the retirement you want. While the amounts can seem challenging at first, the good news is that you might not need as much as you think.
What do retirement savings get you?
It should be fairly easy to work out what you’ve got saved - just add up the amounts in your pension pots, or other savings if they are to be used for retirement.
You can then consider how much income your pot could generate. There are a number of different ways to access and use your pension money. You can read about choosing your income options here.
Broadly, those looking to create a recurring income from their pot have a couple of options. They could give over their savings to buy an annuity, which pays a guaranteed income for life, or they can leave their money invested and then make withdrawals from the pot, either through drawdown or via lumps sums. You can also use a combination of these options.
Rates on annuities have been improving and a healthy 65-year-old with £100,000 of pension savings could currently turn that into annual income of around £5,325, with that rising by 3% a year.2
Drawdown is a popular choice because it allows you to use the money you’ve saved to generate an income while retaining ownership of it. It gives the flexibility of being able to receive regular money to live from but with the remainder of your pot still invested and available if you need it - including to pass on after death free from Inheritance Tax.
In drawdown, the amount you can withdraw is not certain because it is influenced by any investment returns or losses your savings make. Our research1 shows that a potentially sustainable rate is to withdraw between 4% and 5% of your household retirement savings in the first year of your retirement, and then adjust that amount every year for inflation. That’s in order for your savings to last an estimated 30 years. Based on that, a £100,000 pot could generate between £4,000 and £5,000 income per year. This is a hypothetical example, and you can read more about making your money last in retirement and how we calculate withdrawal rates.
Why you’ll need less than you think
Seeing those figures for the first time can be discouraging. For most people, generating an income from savings that matches their pre-retirement salary will be very hard, if not impossible.
But there is some good news. First of all, you may not need as much to live on in retirement as you do as a working person, because some costs like paying a mortgage or forking out for children tend to fall away as you reach retirement age.
That’s not all. The fact that you are saving money during your working life (or should be) means that, although you earn more as a working person, a proportion of this money is not actually available to you for spending. Once you hit retirement you can turn from building your pot to spending it, and no longer need to shovel a chunk of your income into savings.
Finally, there’s some help in the tax system as well which means those past their State Retirement age get to keep a little bit more of their money. And, of course, they may have the State Pension itself to boost their income.
Taken altogether, these things mean that the amount you need from a retirement pot to match your salary as a working person may not be as high as you think.
A £60k lifestyle on £29k?
To help show what we mean, consider the example below which looks at the case of someone earning £60,000 before they retire. As a working person they could currently expect to take home just over £3,6542 a month after paying tax and National Insurance. If they were contributing to pensions and other savings, however, the amount they have available to actually spend is lower.
Were they contributing 10% of their salary to a pension (not including anything their employer may pay in for them) their take-home pay would fall to just over £3,4332 a month. If they were then saving £500 of their pay into savings - into an ISA, say - the money available to them each month for living expenses drops again to £2,933.
How much would it take to recreate that £2,933 a month of expendable income in retirement once they’ve hit their State Retirement Age, stopped working and ceased their saving?
Believe it or not, thanks to the fact that National Insurance is no longer due for those over their State Pension age, and because they no longer need to set aside amounts for saving inside and outside a pension, the annual income they would need to produce £2,933 a month to spend would drop from £60,000 to around £41,0002.
And, of course, they will be receiving a State Pension, the full entitlement of which amounts to £10,600.20 a year in 2023/244.
So - the amount they have to generate from their own retirement savings income (not including State Pension) to leave with them the same amount to spend each month would be a little over £30,000 - a little under half their £60,000 pre-retirement salary.
This is purely an illustration and we’ve made a number of assumptions about their circumstances. In particular, that they are eligible for a full State Pension, which requires 35 years of National Insurance contributions, and that they go from saving significant sums as a working person but then cease their saving completely once retired.
But it helps to show how income in retirement may not need to be as high as you first imagine.
When funding your retirement seems like a struggle, that should be welcome news.
To help you get a better idea of the retirement income you'll need, why not check out our retirement planning calculators.
1 Fidelity International’s Retirement Savings Guidelines Sept 2020.
2 Sharingpensions.co.uk, 25 November 2022. Annuity rates based on a 65-year-old, non-smoker, single life, 3% escalation, no guarantee and a central London postcode using a purchase price of £100,000. Income is gross per year (before deduction of tax) and payable monthly in advance for the whole of the annuitant's life. No medical enhancements are included in these annuities.
4 GOV.UK, The new State Pension 2022/2023
Important information: This is for information purposes only and the views contained are not to be taken as advice or a recommendation for any product, service or course of action. Tax treatment depends on individual circumstances and pension rules may change in the future. If you need advice about how any of this information applies to you personally, you should contact an authorised financial adviser. You cannot normally access your pension savings until age 55. This is due rise to 57 in 2028.