How we do our retirement saving guidelines calculations
The rules of thumb do not take into account the product that your savings are in - whether you are saving in an ISA, or a pension, or anything else. In particular, this means that it does not take into account limitations or tax treatments of individual investment products. In particular:
- It does not take into account the Lifetime Allowance on the overall value of your pension savings.
- It does not take into account the Annual Allowance or Earnings Cap limiting the amount that you can contribute to a pension.
- It does not take into account tax relief on pension contributions, or any additional tax due on the income taken from those pensions.
The rules of thumb are based on an assumption that people invest in a diverse portfolio of different assets including some stocks and some bonds. Your own investments might carry more or less risk than what we have assumed, which will change your expectation of returns. In particular, if you have a high proportion of investments in a single business or property, our forecasting assumptions are unlikely to be relevant.
The rules of thumb presented in this tool are based on a set of generic long term assumptions for investment returns which are reasonable for an average 40 year investing life (see numeric assumptions, below). If you are within a few years of retirement, these rules of thumb are likely to be less appropriate for you.
- The assumed growth or investment return on your savings is based on the assumption that people begin saving at around age 25 and save to age 68. The closer you are to retirement, the less reliable these long term growth assumptions are for you. We assume that you invest in a mixed portfolio of investments, taking less risk as you get closer to retirement. We can provide more information about the underlying assumptions in the Detailed Investment Assumptions section below.
- We assume that, whatever your household income is when you retire, you should be trying to replace around 35% of that from your savings after you retire - this is your retirement income goal. You will also have two state pensions on top of this, which makes your total retirement income need in retirement some 55-85% of your household earnings before retirement depending on how much you earn at the time. This is based on some detailed analysis of household saving and spending patterns. This analysis is based on households with a combined income at retirement of between £30,000 and £100,000.
- We assume that prices rise at 2% each year, while your household income rises at 3.75% each year (or 1.75% above inflation) - meaning that you should see an increase in your spending power over time.
- We assume that household income is gross annual income (i.e. before tax).
- We assume that you have a life expectancy after you retire of around age 92. We also assume that in two person household, you are roughly the same age.
There are two ways of generating an income from your retirement savings - you can use your savings to purchase a fixed income called an “annuity”, or you can invest your savings yourself, and draw down from it to fund the income you need. We assume you will do the latter, which is called “drawdown”. This means that you are taking a small amount of money out of your savings each year to provide yourself with an income, while the balance of your savings remains invested. This means that there is a risk that you could take an income that is too high and thus run out of money before you die. This will depend on how much you take, and how your savings perform in retirement. In order to project what a potentially sustainable level of income is, we therefore need to forecast how your savings will perform in retirement - please see investment assumptions below.
Note that this analysis does not take into account the limitations or tax treatments of individual investment products, such as your tax free cash lump sum, or the tax due on any remaining income and therefore these rules of thumb are very general in nature.
Detailed Investment Assumptions
- We assume that you invest in a portfolio containing 85% equities at age 25, and reduce this down to 25% equities by age 68.
- In order to select an investment return for your investments before retirement, we ran a forecast looking at the potential range of different results this portfolio might get and how likely they are. From this range of results, we chose an outcome that you could expect to see 80% of the time or more based on the assumptions used in the forecast - under this scenario, your investments are assumed to grow at an average rate of 4.75% each year (or 2.75% above inflation) over those 43 years before you retire.
- In order to select an investment return for your investments after you retire: we ran a forecast looking at the potential range of different results this portfolio might get and how likely they are. From this range of results, we chose an outcome that you could expect to see 90% of the time or more based on the assumptions used in the forecast - under this scenario, your investment can be assumed to grow at an average rate of 4% each year (or 2% above inflation) for the rest of your life.