Retirement Income planning is more important now than ever with the increasing cost of living and rising inflation rates. What’s more, it’s never too early to start planning your retirement as the earlier you start planning, the more time your money will have to grow in value.
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What is retirement Income planning?
Retirement Income planning is a process that ensures that you have enough money to live on after you stop working. Retirement planning is not just about saving up for the future but also about how you will spend your time in retirement. This includes things like your lifestyle: whether you will want to take on volunteer opportunities and where and with whom you might want to live in retirement.
5 Reasons You Need to Pay Attention to Your Retirement Planning
Retiring won’t be easy if you don’t plan for it
Waiting till you retire before you decide what to do upon retirement might mean you have a shocking and more problematic transition into retirement especially if you depend on work for social and other interactions.
Knowing exactly what you will do is difficult if you are still young, but thinking about what you can do with a lot of free time can spur you to start planning more rigorously towards retirement.
Retirement can be a time when dormant passions spring to life. Although, certain things are more difficult to do in old age so it’s best to start doing the things you are passionate about now rather than wait till retirement.
Life expectancy is rising rapidly, and the average age is going up, too
Because life expectancy is rising, the UK state pension age (the earliest age you can start receiving your State Pension) has been changing and will be continuously reviewed. My official age for retirement is 68 at the moment. What if it is increased again? Whilst it is possible currently to access some of your pension funds at age 55, this will be increased to 57 from 2028. And who knows what will happen in the future? There is also a lot of politics tied to pensions so it is wise to not depend on it fully, especially if you hope to retire early.
Retirement Income Planning means that you can take control of when and how you retire. That way, the state pension will be an additional safety net. If you are in the UK, you can check your state pension age here.
Pensions are not as before, although it’s not all bad news
It isn’t bad news overall. Part of the recent review of pension in the UK requires that most employers provide a workplace pension scheme and automatically enrol you in one if you meet certain criteria. They will also match your contributions (minimum 5%) from a minimum of 3% unless you choose to opt out. So that you have at least 8% contributions into your pension.
Because employers are now having to enrol and contribute to the pension schemes of employees, it is important to take advantage of this as part of your retirement income planning by enrolling in a workplace pension. The additional income from your employer’s contribution and tax relief will go a long way to boost your retirement fund.
Saving money for retirement now means you can spend more as a retiree later
Retirement Income Planning guarantees that you have a decent lifestyle. The maximum state pension you can get in the UK is 179.60 a week (£9,339 a year). Provided you have national insurance contributions for up to 35 years.
This and any additional pension/savings you have will determine your lifestyle and how well you can live in retirement. According to the charity, Age UK, over 2million pensioners are living below the poverty line. Whilst you will be able to access benefits, this can leave you with limited choices. Retirement Income Planning will ensure that you have enough to have your desired lifestyle.
The right investment strategy can make your savings last longer than you might think
Planning for retirement can ensure your money goes further. Knowing the right kind of account for tax efficiency, the importance of maximising your employer contributions and how best to monitor your pension funds is important to ensure your funds go a long way. Time is of the essence with retirement planning.
Planning for retirement sooner than later ensures you take advantage of time and compound interest. The earlier you start the less amount you will need as investing and compound interest means your money can work harder and longer to generate the additional amounts needed.
When should you start retirement Income planning?
The simple answer is now! The earlier you start the better. Don’t think that it is something you cannot afford. This is one of the areas where compounding can work best for you.
How should you start retirement Income planning?
1 The first step in creating an outstanding retirement plan is to decide what it means to you.
Envision what kind of retirement you want to have when you might want to retire, where, and the sort of things you will like to do. For example, do you want to retire early, travel, volunteer, learn new skills, doing absolutely nothing because you earned it, help with the grandchildren, move to the country, move abroad. Think and dream about it. Any plan beyond downsizing to the country life to live a simple life will require a lot of funds so you can start saving towards it.
2 Once you have defined your needs, you can determine the target retirement date and income goal.
There are several ways to do this. Let’s focus on two;
Use a retirement Calculator
You can use a retirement calculator like this one by Pensionbee to determine how much money you will have by your desired retirement age and how long it will last, based on what you are/ or intending to contribute.
It would be worth checking what benefits you have accumulated from previous and current pensions. If you have had several jobs, you can use the government tracing service free of charge to find contact details of workplace pension schemes, contact the pension administrators for information about any pension funds they hold for you and check which ones you can consolidate.
Some pension providers offer a pension consolidation service and will do all the tracing and work for you for a fee. Once you have determined how much you will likely have based on your current contributions, tweak the information on the retirement calculator to see how sooner you can retire if you increase your contributions or how much more you can draw down if you worked a few more years.
Calculate your Financial Independence Retire Early (FIRE) number.
Your Financial Independence Retire Early number is the amount you need to save to allow you to retire without needing to work for money. Use this simple formula to work out your FIRE number. This will be your income goal.
FIRE number= Yearly expenditure × 25
For example, if you need £25000 per annum to cover your expenditure, your fire number will be 25000 × 25= £625000. Assuming you have this invested and generating a modest return, you can then withdraw 4% of £625000 annually from your investment pot to cover your annual expenditure.
£625000 × 0.04= £25000.
The 4% withdrawal rate was adopted from a study called the trinity study on sustainable withdrawal rates from your retirement portfolio and is popular amongst members of the financial independence movement and the FIRE community
Your portfolio needs to generate above 4% for you to withdraw safely without dipping into your capital. Some people choose to be more conservative with the withdrawal rate. Let’s say you prefer a conservative rate of 2.5%, your fire number can be calculated as such;
FIRE number =Yearly expenditure ÷ 2.5%
Using the previous example, £25000/0.025 = £1,000,000
This means you have achieved financial independence and can retire when your savings/investment pot reaches £1,000,000. Remember achieving FIRE includes retiring very early so your income goal will likely be higher.
3 Finally, you will need to calculate the monthly contributions necessary to reach your goals
Calculate the needed monthly contribution using this formula: Monthly Contribution = (annual income goal) / (number of years until retirement) x 10%
Following from the previous example, Assuming £625,000 is your income goal with 25 years to retirement;
Monthly contribution = £625,000/25 × 10%= £2,500. This means you have to save £2,500 monthly to achieve financial independence in 25 years.
£2,500 is a lot for most people, but this is a straightforward calculation mostly used to achieve FIRE. Your income goal could be lower if you already have funds in pensions and savings and investments or can lower your cost of living. In this instance, using the retirement calculator in number 2 above might be an easier way to work out any additional contributions needed.
The important thing to note is to tailor your retirement income planning to your needs and circumstances.
Note that the working above assumes a return on your investment of 10%, you can lower the rate of return to be conservative. However, the S&P 500 has on average returned around 10% since its inception. Although, actual return for individuals will depend on the price point on entry and exit.
Investopedia
My personal experience and plan
Moving to a new country, working in temporary roles, shelving lots of cash in visa fees and renewals and just trying to settle set our retirement planning back a good few years. My husband is also self-employed without access to a workplace pension, so retirement income planning is a major challenge for us.
I have since revised my desired age for retirement, while this would have felt like a compromise previously, it isn’t now as I would have carried on working and filled my time even if I retired at 40.
Here are some of the practical steps I am taking/have taken towards planning for retirement
- I contribute to a workplace pension and make the highest possible contribution to benefit from maximum employer contributions and tax relief. If you are self-employed you can set up a personal pension. In the UK, this can be a stakeholder pension or a Self Invested Personal Pension(SIPP), you will get tax relief from 20% on any amount you contribute to your pension. You can find more information about personal pensions here.
- I opened a Lifetime ISA (LISA). I have a stock and shares LISA but it is also available as a cash account. You can only open this if you are less than 40 years old and can only access your funds to buy a first home (there are rules for this) or when you turn 60. There are penalties if you withdraw outside these 2 rules and it is considered as a saving should you need to access government benefits, unlike a pension. Please do your research to check if this is right for you. You receive a 25% top-up from the government for any amount you add to a LISA up to £4000 per tax year. Also note that this forms part of your annual ISA limit.
- Invest in a stock and shares ISA regularly
- Start to overpay on the mortgage to become mortgage-free
- Invest in a 2nd buy to let property
If you have left it late it’s not hopeless!
All of the above feels a lot in my current circumstances compared to someone who is younger and has time to put a plan in place with very little pressure. However, it’s not hopeless. Regardless of age, you can put anything from a 5-20 year plan in motion to build and plan for retirement. Remember to get creative and open if things are tight. Relocating, downsizing and simplifying your lifestyle are options that can bring your living costs down.
What I am hoping to do is to gradually work on the above plan with numbers 1, 2, and 3 happening concurrently while 5 and 6 will be started shortly. We are not in our forever home yet so we have chosen not to overpay on our mortgage and invest what we can instead. There is a whole debate about investment versus mortgage overpayment but I believe it’s down to personal preference and circumstance.
A similar argument goes for investing in property. With the changes to taxes on 2nd properties in the UK, yields on buy to let investment properties are lower. Investing in property is something I like the idea of but am less excited about after working the numbers on a spreadsheet. It is still a good asset class to have in one’s portfolio for diversification so definitely one to keep on the cards.
Overall, if plans 1-6 works out well, The idea will be to use the passive income from the property investment plus drawdown on Investment ISA to fund retirement before 60, drawdown the LISA from 60 to retirement age which is 68 at the moment after which the company and the state pension can then kick in.
Coast FIRE
There is also something called coast Fire where you gradually face out work by going part-time while drawing down some of your retirement funds. In this instance, because you will still have income coming in from working part-time, the amount you draw from your retirement funds is lower. Here is a coast FIRE calculator by WalletBurst, it is in dollars but will give you a good estimate of your coast FIRE age and number.
Conclusion
I hope this post has given you a lot to think about or a nudge to start planning for your retirement with more purpose. Nothing can be done without determination, discipline and there might be some self-sacrifice along the way. If you don’t have a budget yet, you need to start one to help with managing your spending and increasing your savings rate. Download our budget guide here to get you started.
Let me know what you think about my step plan and what action you will be taking towards retirement income planning in the comments below.