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Budgeting for retirement

Just how much income will you need in retirement?

The classic 20th century answer, based on the civil service pension scheme, was two-thirds of your final salary in the year before retirement. The two-thirds figure was based on 40 years’ service in a final salary pension scheme with the same employer.

In the 21st century, working life is different. If you are a member of a final salary scheme, you are either a public sector employee or lucky in your choice of private sector employer. Either way, you are unlikely to clock up the 40 years’ continuous service usually needed to generate a ‘two-thirds pension’. Even if you do, you would probably discover that a two-thirds pension is not what it seems:

Final salary pension scheme benefit calculations usually revolve around basic salary – bonuses, commissions, regional weightings, profit shares and other earnings are rarely pensioned.
Similarly, fringe benefits – such as the company car and medical insurance – are left unpensioned. So too are the hidden non-taxable benefits, such as air miles.

Depending on the extent to which your basic salary is supplemented by these other benefits, what starts out as two-thirds of final salary can easily turn out to be less than half of your total remuneration.

Similar considerations apply if you run your own business. You may not have a complex ‘remuneration package’, but often the business will meet expenses that would have to come out of your own pocket in retirement.

The conclusion is that the starting point for calculating your retirement income needs should not necessarily be based solely on today’s basic earnings. What you should consider doing is to work out in today’s terms what you will want in retirement, including the true cost of all those non-cash items.

When you compare your needs with your projected pension income, you will need to ensure that you are comparing like with like. Pension illustrations can either show projected benefits in ‘real’ terms, ie taking into account the effects of inflation, or nominal terms (ignoring the effects of inflation). The ‘real’ figures are what you need to look at if you are using today’s terms to assess your needs.

You may discover a substantial shortfall between your real retirement needs and your current pension provision. This shortfall can be addressed in a variety of ways:

You can increase your pension contributions, either to existing or new arrangements. In many cases, the main constraint now will be what you can afford.
You can increase your non-pension savings, for example by taking full advantage of Individual Savings Accounts.
You can scale back your assumptions about your retirement standard of living.

For further guidance, including help with pension projections and typical financial costs in retirement, please contact Daly Harvey Morfitt on 01789 299655.

Notes on using this fact sheet:
This fact sheet is published solely to provide information and it does not constitute advice or a personal recommendation. Always take detailed financial advice from a suitably qualified individual before making important financial decisions.

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Daly Harvey Morfitt. 8 Shottery Brook Office Park, Timothy's Bridge Road, Stratford-upon-Avon, CV37 9NR. Tel: 01789 299655 Fax: 01789 264685