I used to be safe to work on the basis of a £1m pension pot to provide what you needed in later life.
This old rule of thumb would be enough to see most people through their retirement years, as long as they didn’t spend excessively, especially in the early years.
More recently, a combination of factors have meant bigger pension pots are necessary to reduce the risk of ruin; running out of money before running out of life.
1 – We are all living longer
During the 20th century, considerable improvements were made to life expectancy thanks to health improvements for younger people, such as immunisations.
Since the 1950s, it has been health improvements for the older population which has driven life expectancy higher.
Back in 1980, life expectancy at birth was 71 for men and 77 for women. Fast forward to 2011 and those ages have risen to 79 and 82.8 respectively.
And of course these are just averages, which hide a wide range outcomes. Half of people will live longer than these average ages.
To cope financially in retirement with living for longer, we need bigger pension pots.
2 – The cost of living has risen
Price inflation might be relatively low at the moment, but even modest annual price inflation over extended periods of time can dramatically increase the cost of living.
Over the past twenty years, the Retail Prices Index (RPI) measure of inflation has risen from 154.4 to 264.8, which means prices have increased by an average of 71.5%.
To put it another way, to buy the same amount of goods and services £1,000 would have secured in 1996 would cost you £1,398 today.
In order to keep pace with the rising cost of living in retirement, you need a bigger pension pot.
3 – Returns from investments are lower
We’re living in a low interest rate, low investment return economic environment.
In other words, it takes a bigger pot of money to secure the same amount of income each year.
Yields on the benchmark 10 year government bond (Gilt yields), which is a widely used reference point for pension annuities, stands at 1.38% today. Twenty years’ ago, the yield was 7.4%.
With lower returns from investments today, a larger pension pot is needed to generate the same level of income in retirement.
How much do I need to retire?
We’re all different and it would be wrong to apply any financial rule of thumb without considering individual circumstances, goals and objectives.
Whilst a £1m pension pot will still be more than enough for some, others will undoubtedly need £2m or more in savings to get them through retirement.
The amount you need to save to retire comfortably is going to depend on a range of factors; when you plan to retire, how much income you need, the amount of investment risk you are prepared to take, whether you face any health challenges, and much more.
You are likely to need a bigger pension pot today that you would have needed at the same age in the past, by virtue of the various factors discussed in this article.
With the help of a Financial Planner, it is possible to quantify precisely how much you need in order to afford the retirement you want.