Pension planning - understanding how much you need to retire

Putting a number on your long-term savings.
How much do you need to retire?
Updated
July 27, 2021

Table of contents

It seems to be fair game in the financial press to make throwaway comments about young people ignoring their long-term savings.

It’s simply not true. In fact, it might be the opposite.

According to the Pensions Regulator, of all Britons getting involved in contributing to their workplace pensions, the biggest hikes in participation have been among the youngest age groups. 

In the private sector, the largest increase was seen in 22 to 29 year olds - increasing from 24% in 2012 to 84% in 2018. That’s thanks, in large part, to the introduction of auto enrolment.

Saving for your pension in your 20s and 30s is important and the great thing is young people are engaged. But, they might still be unsure of how to plan for the future or how much they need to be able to retire.

Let’s have a look at exactly that.

Why save for retirement?

Older generations didn’t have to think too much about retirement in their early years because they had gold-plated defined benefit pensions waiting for them. These paid out a set amount each year after their leaving party and grandparents across the country probably still rely on them.

These schemes became really quite costly for companies to administer so they have been phased out for the most part and in their place we got defined contribution pensions.

In these workplace schemes, there aren’t any guaranteed income streams attached. Rather, you reap what you sow and it’s up to us to contribute now, so that our money can snowball enough over time to provide for our future selves later down the line.

Advances in medical technology and all-round healthier lives mean our third age is likely to be even longer than our parents’. That’s a great thing to look forward to but it means our retirement savings will have to stretch even further.

How much we contribute to our pensions now and what we do with our money once it’s in there will have a direct impact on what lifestyle we’re able to give ourselves in retirement.

So kick-starting your retirement savings early is important.

But it’s not just about shoving as much cash under the mattress as possible.

Regardless of which account you use, the main reason it’s so critical to start early is that the biggest asset you can give to your investments is time.

When you gain interest on your savings or investments, over time that interest gains its own interest and creates a compounding effect that gathers pace the longer you leave it.

One advantage we do have now is that it’s never been easier to take charge of your investments, or choose a stocks and shares app.


Work out how much retirement income will you need

This starts with you and what expenses you expect to have. 

Most people find they can live on two-thirds of their salary. Traditionally, this is the level defined benefit pensions have targeted and takes into account lower expenditures after you’ve hopefully paid off the mortgage and have fewer child-related things to pay for.

Expenses are one thing but how much income you’ll need on top will depend entirely on what sort of discretionary spending you have in mind.


And this is where the calculations have to become a lot more personal. On top of your basic cost of living, how many holidays do you plan to take each year? How often do you think you’ll eat out? Do you desperately want to do up the bathroom?

Sometimes people expect to cover one-offs like renovations, children’s weddings or paying off the mortgage with their 25% tax free allowance. But you don’t have to use it all at once. Instead, you can factor it into the steady income you withdraw from your pension pot, letting you spread the benefit over time.

Additional income sources

It’s important to think about where you plan to get your income from long before you intend to access it. 

Young people are much less tied to their employers than previous generations so it’s likely you’ll rack up a range of different pension pots over your lifetime. 

This could include a mixture of defined benefit and defined contribution schemes, especially if you’ve worked in both the public sector, in teaching for example, and the private sector as well.

But outside of your workplace savings and investments, are you planning to use any other sources of income later in life?

Property as a pension?

In a property-obsessed nation, most often rental income from investment properties crops up as an auxiliary source of income to supplement many people’s pensions.

There are big pros and cons to planning to live off rental income in this way.

Yes, there is the chance of returns from both rent and any capital appreciation the property enjoys but, like the stock market, there is no guarantee house prices will rise. 

And remember you’ll have to factor in costs associated with maintenance, repairs, insurance, tax and maybe a few headaches from troublesome tenants or lean periods when the property lies empty.

Another thing to consider is the risk involved in buying an investment property using a mortgage. When people do this, the asset they buy is worth more than the money they have spent to purchase it. They then have to keep up the mortgage repayments with any capital growth amplifying the returns they make on their invested money. 

In investment terms, this use of borrowing money to increase gains is called gearing. It can make gains larger but there is a risk that the value of the property falls below the value of the debt - known as negative equity. You still have to repay that debt which means you could lose more than you invested in the first place.


Another risk is that houses are much less ‘liquid’ than shares. That means it can be harder to sell a house if you ever need the money. And you can’t sell part of it and buy it back later in the same way you could do with shares. 

This isn’t to say one strategy is better than the other, just that there are risks involved in property just as much as in the stock market. Recent house price growth might have stopped people thinking about them but they are very much still there.


Pension and inflation

The reason investing in a pension is important, and not just stockpiling cash, is that inflation eats into what that cash can buy over time. It’s the reason your granny gives you £1 and thinks you can buy the whole newsagents with it, because in her day you probably could.

You both recognise the £1 coin but what it has been able to buy over the years has slowly succumbed to the effect of inflation.

With investing, you’re at least trying to keep up with inflation so that your money can still buy the same value of products and services and might even grow above that.

Investing in companies whose earnings are outstripping inflation, and whose ability to reinvest in themselves also produces a higher return than inflation can help offset the eroding effects.

There are also assets like inflation-linked bonds, designed to at least help your money keep up with inflation.

Throw in healthy dividend-payers and your portfolio could help save you falling victim to inflation over the long term.


How to calculate your target retirement income

As we’ve said, our distinct takes on retirement lifestyles make sweeping statements on the size of your individual pension pot unhelpful at best and irrelevant at worst.

There are a couple of rules of thumb you can use but remember, to make it actually worthwhile you’ll need to factor in what you, specifically, are expecting later in life.

You’ll sometimes see general guidance that says you need somewhere in the region of seven to ten times your income at the point of retirement or a certain amount by each stage in your life.

It’s not an exact science, but thinking this way can give you a yardstick to measure yourself against along the way. Don’t get discouraged if you think you’re behind though.

Younger people in particular will see changes to what they might want from retirement and what they can realistically plan for throughout their lives.


That’s because they are still likely to have a lot of life’s key expenditures ahead of them which will constantly change perceptions of value and will steadily refine what they deem to be achievable or even desirable standards of retirement living.

House deposits, weddings, children and all the life goals that often require money before we get to retirement ages will have a knock on effect here.

And that’s not even taking into account our salary trajectories, which can change massively over the years.

But we should take into account that, by and large, by the time retirement comes we’re likely to have fewer or lower expenditures than during our working lives.


When it comes to regularly taking money out of your pension to live off, a commonly accepted rule is to not take out more than around 4-5% of the total value of your savings in any one year. 

The goal here is to keep the underlying investments ticking over, and able to generate even more income for next year without chipping away at the pot underneath. 

For most people, 4-5% sits in this sweet spot. That might change if the dividend outlook in global markets rises or falls but it is a reasonable starting point.

Whatever you decide later in life though, it’s important to remember that it’s easier to make changes to what you want at that stage rather than this one. You won’t be able to go back in time and save more.

When to retire and how much to save in your pension pot

Leaving the money aside for a second, have you thought about if you actually want to completely retire or not?

Maybe you can’t wait to put your feet up. But you might want to turn a hobby into a part-time job or become a freelancer in some respect just to keep busy.

That, along with your health and financial goals will help you decide when you want to take a step back from fulltime work.

At the moment, the earliest you can access your pension is at 55 years old (with murmurs that it will be rising to 57 soon) and if you’re currently aged between 20 and 39 you’re likely to receive the state pension from 68.

And if you’re clinging onto that 4% withdrawal rule, a good way to plan for that is to multiply your current annual spending by 25. That's roughly the size of investment portfolio you’d need to safely withdraw 4% each year.

How much to save for early retirement

It’s what a lot of people want to do, hence the whole Financial Independence Retire Early (FIRE) movement. But this extreme form of frugality means earning a lot, spending next to nothing and becoming rich enough to be basically poor for the rest of your life.

For most people, the thought of early retirement doesn’t mean downing tools in your 30s, it’s more likely to be about stepping away from work or reducing hours in your late 40s or early 50s (the dream).

So ‘how much?’ will depend entirely on what you plan to do, if you want to give up work completely, and how aggressively you’re saving and investing now.

There’s a different angle here though. Rather than just reel off the usual ‘save more to retire earlier’ message, a practical solution might be to start drawing income from your ISA before the age of 55 when you can access your pension savings.

There’s a trade off here because your ISA investments won’t attract tax relief or employer contributions but they are easy to access before retirement. And as investment ISAs are tax-efficient, like pensions, you’ll keep all the gains your investments make inside them and won’t pay tax when it comes to withdrawing your cash.

This will take planning, as the questions of ‘how to become an ISA millionaire?’ will probably have to give way to your ISA adopting a supporting role rather than centre stage.

What retirement lifestyle do you want?

We’ve talked a lot about how our expectant lifestyles will dictate what we’ll need from our pension pots so let’s look at what three simple scenarios might prompt us to consider.


  • Basic retirement

If you don’t have an extravagant lifestyle, it might be the case that you’re ok with a steady modest income with no room for frills. 

Bear in mind inflation has just as much of an effect on the money in your pension pot after you’ve given up work though. It’s rarely the case anymore that you can cash in your pension, stick it under the mattress and take a few notes out when you need them. Those longer lives we mentioned mean that cash will still need to have the chance to grow. 

If it’s not earning any interest at all, and is falling victim to inflation, its value could be eroded quicker than you think.

  • Comfortable retirement

A little bit of what you fancy does you good. For most people that will mean the odd treat like a holiday or taking the family out to dinner. These nice-to-haves mean planning to not only meet basic living costs in retirement but bolstering your discretionary spending capabilities too.

That could mean that investment growth is still important even in retirement and just keeping up with inflation won’t cut it. Of course, it depends what your pension looks like when you retire but keeping the door open to a higher level of spending means growth assets like equities are probably going to play a part. 

  • Luxurious lifestyle

If you’re planning to follow the sun wherever it goes or splash out on the retirement party to end all parties, having access to high levels of disposable income means your cash will have to be working hard, even if you aren’t.

This could mean allocating even more of your money to growth assets like equities but that also involves accepting a higher degree of risk.

If you can plan to live off the natural income from income-producing assets like dividend-paying shares and investment trusts that could help even more.

Leaving the crux of your portfolio to rise over time, rather than constantly dipping in and preventing its ability to grow, could mean your pot lasts even longer.

How much do you need to retire as a single person?

There is some research to suggest a single person would need an income of around £33,000 per year to live through retirement with no money worries.

The study conducted by Loughborough University and the Pensions and Lifetime Savings Association (PLSA) found that £33,000 per year was enough to allow retirees to spend £56 each week on food, enjoy three weeks’ holiday in Europe every year and spend £1,000-£1,500 on clothes each year.

At the lower end of the spectrum, a retirement income of £10,200 per year would let a single retiree spend £38 per week on food, take one week’s holiday and a long weekend in the UK each year, and have £460 per year to spend on clothes.

For a bit of perspective, using our 4-5% withdrawal levels you would need to generate a pension pot of £100,000 to provide an income of £4,000 to £5,000 a year.

To generate £33,000 and only take 4% from your pension, your total starting pot would need to be £825,000.

How much does a couple need to retire

For couples, £15,700 would be enough to achieve a minimum living standard according to the study. That figure rises to £47,500 for couples hoping to enjoy a comfortable retirement.

If couples were aiming to hit these figures between them in their first year of retirement, the lower and upper pension savings pots would need to be worth £392,500 and £1,187,500, assuming a 4% withdrawal rate.


How not to run out of money in your retirement 

Running out of money with no way to earn more is a scary prospect. That’s why simply depleting a cash pile over time as a retirement strategy is so precarious. Bluntly, to make that work you need to know when you’ll no longer be here, and that’s both a morbid and unpredictable task.

Instead, it’s increasingly important for those pension pots to stay invested so they reduce the chance that we’ll run out of money.

As we’ve said, a good way to go one further is to leave these assets along and live off whatever income payments they send your way. Over the past few years this has meant investing in dividend-paying equities because low interest rates have taken the shine off bonds’ ability to pay a decent income. 

If bond yields start to rise and interest rates make taking risk in the equity markets less attractive, that income baton could be passed to the bonds in your portfolio.

That brings in an important point about having a portfolio that is able to draw income from various sources. Diversification and close attention to the interest rate environment is key in this respect.

If this talk of assets is piquing your interest, maybe have a look at our beginner’s guide to investing in the stock market.


Types of pensions 

State pension

You can also factor the state pension into your retirement planning. It’s a regular payment most people are entitled to, once they reach a certain age.

You can find out your state pension age here but as we’ve said if you’re currently aged between 20 and 39 it’s likely to be 68.

The amount you’ll get under the state pension also depends on how many ‘qualifying’ years of national insurance contributions you have under your belt by then.

You can find out what you’ve paid so far here.

At the moment the most you can expect from the full new state pension is £175.20 per week.

That’s not a king’s ransom by any means, and all the more reason to level-up your own contributions to kick start that compounding effect now.

Workplace pension

If you earn more than £10,000 (from one job) and are aged between 22 and the state pension age, both you and your employer have to pay a percentage of your salary into a workplace pension scheme.

Since April 2019 the minimum contribution your employer must make is 3% of your salary.

And the minimum total contribution (you + your employer) is 8%. So, if your employer is putting in that 3% (they can pay more if they want to) your minimum contribution must be 5%.

Another point here is that your contributions are made from your pre-tax salary so, for most people, the hit to your spending power ends up being less than you think.

And finally there’s how these contributions are worked out.

For the current tax year, they are based on your ‘qualifying earnings’ which is all pre-tax employment income between £6,240 and £50,000.

So 8% of all of your earnings in this bracket will be automatically contributed to your workplace pension.


SIPP

A self-invested personal pension or ‘SIPP’, is a type of investment account available to people in the UK designed to help you save for retirement. 

Rather than passing the job onto the company behind your workplace pension scheme, a SIPP lets you decide what to invest in.

SIPPs can be particularly useful if you have a few pensions from previous employers knocking around.

Young people today are expected to have around 14 different pensions by the time they retire so bringing them altogether in one place looks set to become even more useful.

The thing you’ll really want to think about before making the move is whether a SIPP is right for you. If you’re unsure about this then seek professional advice.

There are benefits to SIPPs but there may also be positives to your existing pension that you’ll lose if you make the switch. 

Make sure you know what you’ll lose if you do transfer your pension to a SIPP and that you see a SIPP as being more beneficial to your financial wellbeing.

Read more: What is a SIPP?


How much should you save into your pension?

Your personal contributions will need to factor in your ability to build your pension pot over time at a rate that doesn’t cripple you.

The rate and level at which you save will help inform other aspects of retirement like when you’ll likely be able to retire and what sort of lifestyle your current ability to save will allow, so the earlier the better.

The pension lifetime allowance for the 2021/22 tax year is £1.0731 million and, as was announced in the Chancellor’s Budget this week, that figure will be frozen until 2026.

This means that when you come to take benefits from any pension plans you may have, you can draw up to the value of the relevant lifetime allowance at the time without additional tax charges, over normal income tax rates, being applied.


There is nothing to stop you having an overall pension fund of more than the lifetime allowance and that might happen if, for instance, your investments have performed better than you expected. 

You just need to be aware that if the value of the benefits you take from all of your pensions exceeds the lifetime allowance then the excess will be subject to a tax charge.

So if your pension fund looks like it might grow to more than the lifetime allowance by the time you take benefits, you might want to think about whether it is worth continuing to make contributions.


Saving vs Investing

The big difference to call out when putting saving and investing side-by-side is the matter of risk. 

Yes, your money is exposed to inflation risk when it exists as cash but the relative certainty of its day to day value is why we can feel more comfortable having it in our hands as opposed to in the stock market.

But risk works both ways, and if you never take any, your opportunity to grow that cash is muted.

You might be sacrificing that relative certainty when you invest in the stock market but you are also giving your money the opportunity to grow over time.

And it’s this last bit that is so important. Risk isn’t about taking a punt on a stock you’ve heard is set to do well. That’s more akin to gambling.

Good application of investment risk means allocating capital to a diverse selection of assets that, together, have the ability to grow your money in line with the businesses you are invested in.

Learn more: Saving vs investing: which one if best and when?

SIPP vs ISA

SIPPs and ISAs are accounts designed to help you save and invest for the future. Both give you access to the stock market. Both are built around tax efficiency (to help you keep more of your investment gains). And both have limits to how much you can put in every year.

But it’s the differences that will help you decide which one is best for your individual goals.

It might be that you end up favouring one over the other, or opt for both. So, SIPP or ISA?


What is an ISA?

An individual savings account (ISA) gives you the chance to save a certain amount every tax year (April to April) and makes sure that any gains you make aren’t going to be gobbled up by the taxman.

You can currently contribute up to £20,000 in the 2021/22 tax year.

As its name suggests, once that money is in your stocks and shares ISA, you can start to buy… well… stocks and shares, as well as other assets connected to the stock market like investment trusts.

This is why you’ll often hear ISAs and self-invested personal pensions (SIPPs) described as ‘tax wrappers’, because they’re just the containers - you get to choose what filling you put in them.

Stocks and shares ISAs are a great way to invest, knowing that you can keep every penny you make along the way.

Another advantage is how flexible they are. You can sell and withdraw your investments whenever you need the money, making ISAs really useful for any savings goal you have up until retirement, and maybe beyond.


The key point is that your money isn’t locked up - you decide when enough’s enough.

You can only have one stocks and shares ISA with one provider each tax year but there’s nothing to stop you from changing providers if you find a new one that’s cheaper or has a range of assets that better suits you.

When you pay into an ISA it’s normally from the money landing into your bank account at the end of each month after you’ve been taxed.

The difference with a SIPP is that your contribution receives basic rate tax relief which is collected by the pension provider directly from HMRC and added on to your own contribution. 

So, if you contribute £80 your pension provider will collect £20 from HMRC making your gross contribution £100.

If you pay tax at a rate higher than the basic rate of 20% you can get even more tax relief on your contribution paid directly to you via your tax return. 

For example, if you pay income tax at 40%, your £80 contribution is boosted to £100 by basic rate tax relief being added to your pension and you can claim a further £20 back via your tax return. 

Therefore the £100 going into your pension will end up only costing you £60.


Annuity vs drawdown

In the old days, it was pretty much obligatory to use your pension savings to buy an annuity when you collected your gold watch and said goodbye to the office.

Annuities allow you to exchange your eventual pension pot for a guaranteed regular income either for life or for a set period.

That meant the years just before you were due to retire were all about taking risk off the table and protecting your investments from falls. After all, the last thing you wanted was to suffer a drop in the value of your pension right before you were going to purchase an annuity. Avoiding losses became key.

The introduction of the government’s pension freedoms in 2015 changed all of that.

No longer did you have to swap your savings for an annuity. Instead, you were free to take control of your own money and decide how best to manage it throughout your retirement.

That’s where we are today. And after initial fears that we’d all go out and fritter away that cash without the guiding hand of an annuity provider, it seems as if the nation is getting on fine.

You can still opt to buy an annuity with all, or part, of your retirement savings but there is another alternative that we’ve alluded to. Drawdown is the practice of keeping your money invested in the stock market and drawing down cash over time from those investments.

It provides less security than a traditional annuity but it offers more opportunity for growth. 

Those regular annuity payments can also have the inflation spectre hanging over them, as they’ll often stay the same even if inflation rises.

And if you’re planning on leaving some money to your loved ones from your savings, think carefully about which way to handle your retirement pot. Often, annuities won’t offer the ability to leave any money to family.

There are a lot of things to consider in this regard. If you need a bit more help to understand your options you can visit the government’s Pension Wise service online at www.pensionwise.gov.uk or over the phone on 0800 138 3944.

Five tips to help you stay on track with your retirement plan


  1. Save early - nothing beats the value of time.
  2. Save often - even small amounts can make a big difference.
  3. Pay attention to account fees - over the long term, they rack up.
  4. Don’t get jittery - don’t make short-term jerky movements, look to the long term.
  5. Diversify - who knows what will fall in and out of fashion, cast your net wide.

Important information on SIPPs

SIPPs are a pension product designed for people who want to make their own investment decisions. You can normally only access the money from age 55 (set to rise to 57 from 6 April 2028).

This article is based on current rules, which can change, and tax relief depends on your personal circumstances. When you invest, your capital is at risk.

The value of your portfolio can go down as well as up and you may get back less than you invest.

Before transferring a pension you should ensure you will not lose valuable guarantees or incur excessive transfer penalties. Pensions are usually transferred as cash so you will be out of the market for a period.

Freetrade does not currently offer drawdown products for our SIPP.

Important information

This should not be read as personal investment advice and individual investors should make their own decisions or seek independent advice.

When you invest, your capital is at risk. The value of your portfolio can go down as well as up and you may get back less than you invest. Past performance is not a reliable indicator of future results.

Eligibility to invest into an ISA and the value of tax savings depends on personal circumstances and all tax rules may change.

Freetrade is a trading name of Freetrade Limited, which is a member firm of the London Stock Exchange and is authorised and regulated by the Financial Conduct Authority. Registered in England and Wales (no. 09797821).

Related articles

Most read