The average 35 year old has managed to set aside £14,000 for their retirement. It sounds like a reasonable chunk of cash, but anyone in this position who has had a pension statement in the post lately will know that this is a disaster. The problem is that when we save for retirement, we approach things backwards - with what we can afford to set aside from our income right now - rather than starting with how much money we need to have in our pension pot when we retire.
This isn't a straightforward calculation, because like everything else relating to our retirement, it depends on a number of variables. However, a few simple rules of thumb will bring you to an approximate target.
Finding your target
First, how much money will you need in income in retirement? Your income requirements will fall from where they are now, because ideally you will have paid off your mortgage, you won't have the costs of working, and your lifestyle is likely to be scaled down somewhat.
The industry works off a rough rule of thumb that you'll need about half the income you needed at the age of 40 - although you'll need to factor inflation into your sums. A report by Scottish Widows put this at roughly £23,500.
Second, what other income will you be able to count on? It's worth getting hold of a state pension forecast, because under the new flat rate state pension, you may receive something very different to the flat rate you're expecting.
You then need to factor in income from other sources, such as wages from any work you do in retirement, interest from savings, and rent from buy-to-let or from renting out one or more rooms in your house.
If you are expecting an inheritance, this can be a dangerous thing to rely on - because it means you will be hanging on for the death of a loved one in order to be able to retire - plus they may spend the cash or change their mind about who to leave it to. However, if you have spoken to your family about this, and if they can leave you some money on a specific date, then you can factor this in too.
If downsizing your property is part of the plan, then think carefully about this too. Do your research, and err on the size of caution when working out how much cash this will free up - and how much it will cost to make the move.
This will leave you with a target.
The next decision is how you intend to generate this income: will you use an annuity or will you withdraw the money from your pension scheme like a bank account? If you opt for an annuity, you should put your target pension income into an annuity calculator, and it will reveal the sum you need in your pension by retirement. There are plenty of them around, including this one from the Money Advice Service, or a more hands-on assessment from the Age Partnership.
If you opt to withdraw the cash in lump sums, you need to think about how long you are likely to spend in retirement, how much income you need from your pension each year, and how much of a safety net you'll have in place if you live longer than expected.
This will establish the lump sum you are aiming for, so the last stage is to translate that into how much you need to be investing every month. There are plenty of tools that will do this for you - including Retireready from Aegon.
What if it's bad news?
It's worth bearing in mind that the vast majority of people are way behind in their plans for saving for retirement. So when you initially put the figures into these calculators you could be in for a horrible shock.
The key is not to be put off by this, because there are things you can do to bring down your target. You can, for example move your planned retirement date, so you set a target of retirement five years later, and consider the kind of work you are happy to do later in life. You might also think about the lifestyle you were planning in retirement, and whether there are more cost-effective approaches.
There are also ways to increase the amount you have in the pot. Consider your investment strategy, and whether while you are younger you can afford to take a more aggressive approach and a bit more risk in the hope of generating more growth.
You should also look carefully at the figure you can afford to put aside each month. In our feature on freeing up cash in order to save it, we reveal some of the ways you can create enough wiggle room in your budget to boost the amount you are putting away each month.
Finally, don't assume that just because you cannot afford to put enough away to hit your target right now, that you are doomed to fall short. You should look carefully at the maximum you can afford to save at the moment, then make a date to revisit your arrangements in a few years. Who knows what may have changed by then, and how much more you may be able to afford.
The general rule of thumb is that we should be saving to hit a specific target - but if we cannot afford to do that, we should simply do as much as we can.