Do you know how much you’ll need to retire comfortably?
Planning for your retirement should mark the beginning of an exciting new chapter in your life, yet, for many, the enjoyment is often overshadowed by a nagging question which steals their peace of mind: "Will we have enough?" Having sufficient assets and income to sustain your desired lifestyle over multiple decades is the bedrock of retirement planning; therefore, ensuring you have enough should be your first priority and main focus. So, where does one start? There are two ways to go about it.
- The quick way: using ‘The Rule of 25’ to act as a rough guide.
- The proper way: building a comprehensive, stress-tested financial plan to give a more accurate answer.
Both methods start with gaining clarity on your current circumstances and then deciding what you want your ideal future to look like. Lets looks through both in turn and then apply them to a case study.
The Rule of 25
This is, quite simply, multiplying your living expenses by 25. So, first you must decide on your future wants, needs and aspirations and how much this will cost on an annual basis (on a net - post tax - basis). Once you have your net annual expenditure, multiply it by 25. The resulting number is used as a rough guide for the amount of invested assets you need to provide you with an income over a 30 year retirement. For example, if you wanted to spend £40,000 per annum, the rule suggests you’d need £1,000,000 invested. As with all rules of thumb, The Rule of 25 is a flawed measure which isn’t specific to your own circumstances and doesn’t take into account multiple variables, such as:
- Where the money is held.
- How it’s invested.
- The tax rules around drawing out the capital.
- Your changing needs over time.
- Any other incomes, such as the state pension (which you can attempt to factor in, but that can get tricky if you want to retire before you begin receiving your state pension).
However, for many, it can serve as a good starting point on their retirement planning journey for gauging their ability to retire comfortably.
Financial Planning
Whilst The Rule of 25 is a generic rule of thumb, a comprehensive financial plan is a highly personalised piece of work which accounts for a range of variables. Here’s the process we go through with our clients, which you can follow:
1. Understand your current financial position (assets/liabilities/income/expenditure).
2. Decide on your future wants, needs and aspirations and how much this will cost on an annual basis? (This will give you an annual income figure to aim for).
3. Review your investments and sources of guaranteed income to ensure they are suitable for your needs.
4. Work out where your required annual income comes from. (Which assets will you draw on to meet your needs? And in which order?).
5. Stress-test your plan to ensure it is sustainable and not overly reliant on strong market returns.
6. Ensure you have sufficient cash holdings in case of unforeseen expenses and/or temporary market declines.
7. Regularly monitor your financial position to ensure everything remains fit for purpose and stay abreast of all tax and regulatory changes as they pertain to your personal circumstances.
The end result will be a much more specific answer to the question of enough and will also highlight any financial levers that need to be pulled to make the desired retirement plan a reality. Now we have an overview of the two different methods, lets apply them to an example of a married couple approaching retirement to help bring them to life.
Nigel & Caroline
Nigel and Caroline are 60 and live in Cambridgeshire. They’ve accumulated £600,000, have had enough of working and have many a plan for how they’d like to be spending their time instead of continuing the daily grind. The only issue is, they don’t know if they have enough. They’ve worked out they’ll need £40,000 (net) per annum to cover their core needs and want a further £10,000 (net) each year to really enjoy themselves, whilst they are young and healthy enough to do so. They both have full state pension entitlement, which will begin at age 67. So, they need to generate £50,000 of net income each year (£4,166 per month). Whilst their state pension will meet c.50% of this need, it doesn’t start for another seven years, which means Nigel and Caroline will have to fully fund the £50,000 from their other assets and income until then. Lets take a look at what assets and income they have to work with and then run them through the two different methods to determine whether they have enough. Assets:
They currently invest in a low cost, 70% equity, 30% bond portfolio and have an additional £50,000 in cash, which is ring-fenced solely for emergencies.Income:
The Rule of 25: Nigel & Caroline
Lets review their situation as it relates to The Rule of 25:
1. They have £600,000 invested and want to spend £50,000 per annum for the first 15 years of retirement, and then maintain at £40,000 from age 75 onwards.
2. They’re entitled to the full state pension (starting in 2033) and Caroline also has a small NHS pension (in payment now). Which, in today’s money, will provide them with a combined guaranteed income of £25,000 per annum.
As you can probably tell, the reality of their circumstances, which is neither neat nor linear, is butting heads with the overt simplicity of The Rule of 25. The varying income needs over their retirement, coupled with guaranteed incomes starting at different times, makes it a challenge to apply the rule. It would be easy for Nigel and Caroline to be told about the rule and simply work out they need £50,000 per annum to begin with and multiply that by 25; however, that would provide a potentially disheartening number of £1,250,000. After a bit of rigmarole accounting for the evolving factors and guaranteed incomes over time, The Rule of 25 says they’d actually need £634,090. Here’s the maths, if you’re interested:
Whilst limited in scope, the above tells Nigel and Caroline that they potentially aren’t too far off having enough. Based on the above, they have three main options:
- Decide to reduce their overall income need (AKA their spending).
- Work a bit longer to save up some extra funds or implement a phased retirement.
- Look to invest more heavily in growth assets to make up the difference.
- A mixture of all three.
Whilst the above sounds good, Nigel and Caroline then need to work out whether the above plan is sustainable and resilient - can their assets safely provide the income they require over multiple decades across various market conditions? This is where The Rule of 25 meets its end. It’s not fit for purpose if you want to stress test the plan in any way and it leaves a number of questions unanswered, such as:
- What if one, or both, of them lives longer than 30 years in retirement?
- What if they experience exceptionally poor market conditions?
- What about the tax implications of drawing from their pensions?
- What if they invest too cautiously?
- What investment returns do they need to remove the shortfall?
- What if they run into a significant event that changes their lives and income needs?
So, how would they go about answering questions such as these? You guessed it! By building a comprehensive, personalised financial plan. Lets dive in.
Financial Planning: Nigel & Caroline
To reiterate: 1. Nigel & Caroline have £600,000 in investable assets and £25,000 of guaranteed income from 2033. 2. They want to spend £50,000 per annum for the first 15 years of retirement, and then maintain at £40,000 per annum from age 75 onwards. Whilst The Rule of 25 works on a 30 year time horizon, that leaves Nigel and Caroline open to what’s known as ‘longevity risk’ - a fancy term for living long enough to run out of money. Therefore, to make their plan as robust as possible, we’ll work on the assumption that they live until age 100.
Life Expectancy
Whilst planning until age 100 may feel overly optimistic, it’s not inconceivable that at least one of them could get close. Here are their estimated life expectancies, which take account of their age (60), gender, health (good) and postcode (CB24) - which are all large determinants of longevity: Nigel (90.2)
Caroline (92.1)
The charts illustrate the uncertainty surrounding their age at the time of death. If we were to start with a group of 1,000 people (all with the same age, gender, postcode and health status) the vertical bars represent the number of people in their groups that are expected to still be alive at each age and marks out when less than 50% are expected to remain.
Plan Sustainability: Do they have enough?
So - the all important question - do Nigel and Caroline have enough to survive a 40 year retirement? Potentially! Utilising cashflow planning software (Timeline), we can begin to get more granular and specific with answering the question. Their plan was successful 66% of the time when ran through 816 historical time periods across the last 110 years of market data - these periods include wars, depressions, stock market crashes, hyperinflation, pandemics and many other negative historical events. They also take into account various factors such as taxes, portfolio returns, their spending habits, and the impact of inflation. Here’s how it looks:
When the grey vertical bar is above a coloured line (which represents their spend), it means they could’ve spent more, when it falls below it means they wouldn’t be able to meet their desired spend.The worst-case scenario occurred between January 1915 and January 1956, during which they would’ve run out of money by the age of 68 (within only 8 years!). However, this scenario could be avoided with some simple adjustments along the way (reducing spending etc.). The best-case scenario occurred between November 1981 and November 2022, which would have left them with £5.46m(!) at the end of their lives (after adjusting for inflation); however, it's important to note that such a scenario is highly unlikely to occur, much like the worst-case scenario. The median scenario predicts that they would have £335,000 left at the end of their lives (age 100). Now, whilst 66% probability of success isn’t horrendous, it is less than ideal. So, what financial levers can Nigel & Caroline pull to increase their probability of success and thereby have more peace of mind that they have enough going into retirement?
Financial Levers
Spend Less The simplest way to improve their probability of not running out of money is to spend less. For example, spending £5,000 less per annum rockets Nigel & Caroline’s plan straight up to an 89% success rate; however, they may not be able to/want to decrease their spending that much - especially whilst they are newly retired, healthy and want to enjoy the fruits of their labour. They may instead like to compromise and drop their spending down as they age. Or, if compromising isn’t in their nature (at least not at this stage), then they may wish to up the equity content in their portfolio and ‘go for growth’. Go for Growth Increasing their equity content from 70% to 100% takes their probability of success across the last 110 years of historical periods from 66% to 81%:
Over most of the 41-year rolling periods, a 100% equity portfolio would’ve been able to provide surplus spending opportunities for Nigel and Caroline. Whilst it looks good on paper, this strategy isn’t without its risks. Equity markets are more volatile in the short term and if Nigel and Caroline run into poor market performance early on then they could be in trouble - this is known as ‘sequencing risk’, which is when poor investment returns early in retirement deplete the portfolio too quickly, making it harder to recover and increasing the risk of them running out of money. As Nigel and Caroline will be solely dependent on their investments for their retirement income during the first seven years of retirement, this approach would need careful consideration. They do have a years worth of savings in cash (£50,000), which they could draw from during a temporary market decline; however, the risk they’d need to accept is the possibility of the poor market performance outlasting their cash savings. What we always want to avoid is selling into a down market whenever possible - this is when cash becomes king. Continue Earning Continuing to generate some level of income, via working part time, is a great way for Nigel and Caroline to insulate themselves somewhat from being solely reliant on the investment markets for their returns. Phased retirements are becoming more common as people are living longer and facing up to four decades in retirement. Whilst Nigel and Caroline don’t want to work, the possibility is open to them if they run into particularly bad market conditions. A Mix of all Three There’s no silver bullet for Nigel and Caroline. It all depends on them. Their thoughts, feelings, tolerance to uncertainty and ability to take on risk. They’re in a favourable position where they can adapt and make changes along the way. Sometimes they may need to spend a bit less. Other times they may be able to spend a bit more, or increase their cash reserves for leaner times. Financial planning is an ever evolving piece of work and is as much an art as it is a science.
Conclusion The wide range of variables in planning inevitably leads to a wide range of outcomes, which is why ongoing planning is so important. Life isn’t static, so neither is a financial plan - the value of financial planning is in the ongoing advice. None of us have a known expiry date and we don’t know what the future holds, if we did, planning would be much easier if so. Therefore, retirement planning requires navigating through the thick fog of uncertainty throughout a multi-decade retirement. So, how much do you need to retire comfortably? It depends! It depends on you. It depends on your health and longevity. It depends on your circumstances, needs and wants. It depends on your tolerance towards, understanding of, and capacity for, risk. The Rule of 25 will help you to get an answer, whilst working with us at rockwealth will help you get to your answer. We’ll then work with you on an ongoing basis to help you navigate safely through the fog of uncertainty, leaving you with the peace of mind to sit back and enjoy the journey. Book in a free, no obligation, 30 minute call if you wish to discuss whether you’re on track for having enough for retirement. Thanks for reading, Tom Redmayne Chartered Financial Planner
The value of investments can go down in value as well as up, so you could get back less than you invest. It is therefore important that you understand the risks and commitments.This isnot personal advice based on your circumstances.All views are my own.
