Saving for retirement is tough, but not nearly so tough as getting started in the first place. To get going you need a retirement plan [1]. To get motivated you can try putting some numbers through a pension calculator [2].
Did that? Disappointed the predicted outcome falls hopelessly short of your expectations?
You’ve got two options. One is to find a big bucket of sand to stick your head in. The other is to set your face against stony reality and work out a Plan B.
I think you know what to do…
A fine example of a plan
There now follows a pension calculator comic strip showing how a failing plan can be put back on course. But first some plot exposition.
Our hero is Corporate Colin. Colin works for da man, slaving away for 30 grand a year as a counter of bean counters in Nowhere Business Park.
Colin is 30-years-old and if he can pull three cherries on the defined contribution fruit machine then he’d like to retire on £20,0001 [3] a year, age 65, in 2047.
2047 – that’s 35 years from now. This thought alone is enough to make Colin reach for the cyanide pills but luckily he stumbles across Monevator while conducting an online price comparison and rediscovers his joie de vivre through the medium of simple investment wisdom.
But I digress. Colin harbours some other dark secrets that you should know:
- He intends to divert £300 per month – or 12% of his salary – into his pension fund.
- That maxes out his matching employer contributions at £150 per month, or another 6% of salary. The calculator assumes that contributions and wages will increase in line with inflation (defined as 2.5% a year).
- Colin’s existing pension assets are zero. Which is slightly higher than his level of respect for his boss.
- Colin has a wife and though he can’t understand how she’d want to live without him, he nevertheless selects the 50% spouse annuity option, just in case. That means his significant other will soldier on with 50% of the income in the event of Colin’s untimely death.
- Our protagonist has even dared to read the calculator assumptions, just in case there’s some hidden knowledge buried in there that he can turn to his advantage.
- He understands that the income projected by the retirement project-o-tron is based on annuity assumptions that will probably bear no relation to his situation in 2047.
- He’s happy to have his income index-linked at 3% a year when he retires because he wants to be able to afford beer at £60 a pint in 2067.
- Colin is keeping his state pension out of it. He’s going to get a forecast [4] done, but wants his state pension to be a buffer in case things go horribly wrong.
- In the nick of time, Colin remembers that his £20,000 retirement income [5] will be taxed. A quick spin on a tax calculator [6] reveals that Colin will be living on £18,100 a year, after tax, at age 65. Colin can accept this. It’ll be 2047 after all and the tax system may well look very different. What can you do?
Colin tires easily and can take no more assumptions. So let’s get on with it.
Fire One – The range finder
Colin enters his numbers into the calculator and dreams of a world without emails marked URGENT!
[7]
Disappointing. An income of £20,000 after 35 years didn’t seem a lot to ask for but nonetheless, our Col has pulled up short. If he doesn’t take action then he’ll be living on £15,000 – which is 75% of the desired amount.
A diet of Aldi spam doesn’t sound great, so let’s consider some alternative scenarios.
Doing nothing is not one of those scenarios as the ‘delaying for five years’ part of the calculator tells a chilling tale of penury. It really is now not never for our hero.
Fire Two – Reduce costs
As a good passive investor [8], Colin will use cheap index trackers [9] to hammer down his investment costs. So he goes into the calculator’s advanced options and turns the annual management charge down from 1% to 0.5%.
[10]
That move alone makes a pretty big difference – projected income is now nearly £17,000 – but at 84% of the target Colin needs to do more. It’s time to suck down some more painful solutions.
Fire Three – Working longer
With a deep breath, Colin dials away a few more years of his life and delays his retirement age [11].
[12]
Putting another three years onto his working life and retiring at 68 does the job for our masked wage slave.
It amounts to no more than the push of a button now, but perhaps working for longer as a part-timer may be less painful when it comes to the crunch. The £21,000 income is a wiggle-room bonus.
Fire Four – Saving more
“No chuffin’ way am I working for those vampires a moment longer than I have to,” thinks Colin in a rare flash of rebellion. How much more do I have to save for retirement [13] to get out at 65?
[14]
Colin’s contributions must go up by another £100 every single month for the rest of his working life to hit his target income by age 65. Though that’s only £80 in actual spending money, thanks to tax relief.
Fire Five – Live on less
Can’t save more, won’t save more? What about getting slash happy on the target income? What difference [5] will that make?
[15]
Colin has to shrink his living expenses to £16,700 a year to make his plan work. That’s a steep 16% drop.
There is another string to pull though. It’s marked ‘hoping for the best’…
Fire Six – The big bazooka
The calculator currently assumes an expected annual return [16] on investments of 7%.2 [17] Colin dances with the devil in return for a growth rate of 9%.
[18]
Wow. All Colin’s problems are solved! The projected income shoots up to £32K per year and the target is busted.
Is 9% per annum possible? Yes, but it’s massively risky to bank on it.
Historically a 60:40 equities and bonds portfolio has averaged 7%. But many are predicting sub-average returns [19] over the next decade or so, especially as bond yields have sunk so low. Investors starting in the early 1980s could have comfortably scored a 9% return, but history has not been so kind to market entrants in the Noughties.
You can see how different asset allocations have faired using Vanguard’s Asset class risk tool [20]. (Click on the grid icon when it loads).
The bottom line is that the more you shoot for the stars, the better chance you have of hitting yourself in the foot.
Fire Seven – Trench warfare
As an antidote to the intoxicating temptations of a 9% return, Colin takes a quick look at the 5% per annum return scenario – and promptly chokes on his digestive.
[21]
Shocking. Earning a return of 5% a year instead of 7% shatters Colin’s dreams. The projected income of £8,600 is 57% less than he needs and would amount to a catastrophic failure of the plan.
This is the nightmare scenario and it can happen to the cautious and adventurous alike. The prospect of low growth is why most of us must bear risk through our asset allocation [22] but the markets can’t be trusted to behave as we would like.
So don’t be over-optimistic, do all you can as soon as you can, and hope it doesn’t happen to you.
Fire Eight – The scatter gun
Suddenly 7% expected growth doesn’t look so bad, but it still leaves our office survivalist battling to close the retirement income gap. Perhaps the medicine will seem less harsh if it comes in smaller doses?
[23]
That does it. By working one year longer to age 66, upping the savings rate another £25 a month (only £20 with tax relief) and cutting income expectations to £19,000 a year, our hero is finally able to create a palatable sacrifice sandwich that doesn’t make him baulk.
Fire Nine – More ammo!
Remember that any retirement plan is about as precision guided as a SETI sweep of the stars in search of ET. Don’t be fooled by the ludicrous exactness of projected income figures. Reality will turn out differently.
Even using a different calculator may get you a very different answer, though the assumptions may seem similar.
[24]
Trustnet’s pension calculator [25] projects a much rosier income of £25,000 per year based on Colin’s original inputs and a 7% growth path. But the Hargreaves Lansdown calculator used for the main example is the most transparent one I’ve found when it comes to assumptions and adjustable parts.
Do let us know about your favourite calculator in the comments.
Fire and don’t forget
Your plan will need monitoring and deft touches on the rudder to stay on course:
- Lifestyling [26] – You may want to lower the risk in your portfolio as you get closer to retirement. Bear in mind this may also reduce your growth rate.
- Rebalancing [27] – This technique enables you to stay true to your original asset allocation when market movements cause it to drift.
- Changes in circumstances – Promotions, inheritance, periods of unemployment, and the rest of life’s rich tapestry may prompt you to revisit your plan and adjust your expectations.
- Unexpected growth rates – Periods of spectacular gain or loss may demand a rethink. Maybe you’ll be able to reduce the risk in your portfolio and cruise home in style if the markets smile upon you. Maybe we’ll end up with the 5% (or worse) nightmare scenario and have to work longer, save more, and live on less. I hope not.
If nothing else, an exercise with a pension calculator shows what a grueling marathon building a retirement pot is for the average wage earner. See you at the finishing post.
Take it steady,
The Accumulator