How do I save a pension pot to retire at 55?
First published 24 April 2018 • Updated 23 August 2019
To retire at 55 is a dream for many people. To achieve it, then as well as a good pension pot you would also need a good plan. Here's how you might set about creating both. Article by Nick Green.
There’s an old joke: ‘Jumping from a plane is easy; the hard part is hitting the ground.’ Similarly, choosing to stop work is something you can do at any age; what’s difficult is supporting yourself afterwards. (You can find out pretty much everything you need to know about that in our Pensions and Retirement pages.)
Anyone with a pension pot can access it however they wish from the age of 55. However, ‘can’ does not mean ‘should’. It’s usually good practice to preserve your pension pot for as long as possible before cashing in any of it, since this will be your main income in retirement. For most people, therefore, retirement will usually come in their mid-60s.
But suppose you did want early retirement at 55? How much would you need to save, and how achievable is it? Here are some of the things you would need to think about - with the help of a financial adviser.
Planning for retirement at 55: start with what you know
Although you can’t predict the future, there are some things you can estimate now with reasonable certainty. Start by asking yourself the following questions:
How much retirement income will I need?
A popular way to estimate this figure is the ’70 per cent rule’, which states you will need 70 per cent of your working income to maintain the lifestyle you want in retirement. So if you retire on a salary of £50,000 you would be looking at achieving an income of around £35,000.
For some people 70 per cent may be generous and they would be comfortable living on less. Conversely, others may struggle.
How might my income needs change over time?
This is another key point to consider. Early in your retirement you may want to spend more, enjoying your freedom, travelling and treating yourself. Later on you may settle down and begin to spend less – but later still there may be a need for expensive long-term care. These changing requirements may influence how you decide to take your pension.
Will I have other sources of income during retirement?
Your pension may not be your only source of funds. Other assets may include:
- properties (e.g. to let)
- spare rooms in your home to rent to lodgers
- working part-time
- running your own business from home
Work out which of these may apply to you, and factor them in to your overall annual income.
Can I work part-time in retirement?
You can work as much as you like after starting to take your pension - even full-time, if you wish. Legally there is no such thing as 'retirement age', and no employer can force you to retire unless it can be proven you are no longer capable of doing the work.
What you do have to bear in mind is your income tax. Pensioners are subject to the same income tax rules as everyone else, so if your income is above the personal allowance you will pay tax on it. Earning a salary may therefore eat into your pension income, thus removing some of the benefits of being a wage-earner.
How much will my state pension be?
You should also eventually begin to receive the state pension, assuming you qualify for it. State pension age is currently 65 for most people and is expected to be 68 by 2044. Currently the maximum state pension pays around £8,767 per year, so you can factor this into your long-term plan (i.e. you may not need to take as much from your private pension once you start to receive the state pension).
You'll only receive the maximum state pension if you've paid 35 or more years worth of National Insurance contributions. The good news is that the state pension is triple-locked at present, which means it will always at least keep pace with inflation (unless a future government changes this).
Which of my costs are fixed?
Think about which of your regular expenses are essential and unlikely to reduce much in later life. Remember that things like food bills, utilty bills and running a car will rise with inflation. You may also have to pay more for things like dental care in later life, or home modifications if you become less mobile. Conversely, other regular costs (such as mortgage repayments) may reduce or disappear. Calculate your fixed costs when deciding how much income you'll need.
Now think about what you don’t know
Certainty is impossible in retirement planning, but you can identify the blind spots in your knowledge and plan around them. Your plan will need to account for the following unknowns:
Pensions and inflation: how much will prices rise?
What will inflation do to the real value of your pension pot? In some ways this is one of the ‘known’ factors, as inflation of some sort is virtually inevitable. In the past 25 years, purchasing power has almost halved – meaning that £1 in 2018 can buy only as much as 50 pence could in 1993. Retiring at 55 might easily result in a retirement of 25 years, or considerably longer, so you’d need to factor in how much your spending power would reduce in that time (and also, of course, between now and the day you retire).
Some investments, such as inflation-linked bonds, are specifically designed to protect against inflation, but consult a financial adviser before exploring any of these.
Will I prefer an annuity or drawdown?
An annuity is a guaranteed income for life. The amount is usually fixed, though you can have one that rises to help beat inflation. The advantage is that it can never run out, no matter how long you live. The disadvantages are that your annual income may not be very much, you may have to live a long time to get full value from it, and you can't vary your income. You also can't leave an annuity to someone else (unless it's set up to cover your spouse too).
A drawdown scheme is very different. Your pension pot remains invested in the stock market, and you draw on it as needed. The advantages are that you can take varying amounts, and if there is money left when you die, you can leave it to your dependants. The disadvantages are that the pension pot depends on stock market performance, so can lose value steeply at times - and running out of money is a real risk.
What will annuity rates be when I retire?
You may decide to buy an annuity (a guaranteed income for life) either when you retire or at some later date. Annuity rates are poor at present, but may change in future. You may also be able to get an enhanced (more generous) annuity if your health deteriorates later on.
How long will I live?
These days, living to the age of 90 and over is not uncommon. If you retire at 55, that would mean a 35 year retirement. Would your pension pot be enough to sustain you over that time? Also the inflation issue (see above) becomes even more pressing – prices in 2018 are triple those in 1983.
How will the stock market perform?
If you keep your pension pot invested and make regular withdrawals (i.e. you have a drawdown scheme), it remains exposed to risk on the stock market, and its value can go up and down. Over time the market generally increases in value, but there are inevitably periods of loss, and sometimes big crashes. Withdrawing money during one of these dips can erode your pot’s value much more quickly.
The power of compound interest
Another big unknown factor is how the investments in your pension fund will perform during the saving-up period ('accumulation'). We've assumed a steady rate of 4 per cent in the calculations below, but it may be higher or lower. You can help your pension along by ensuring it is invested in the best pension fund for you - most workplace pensions start off in the default fund, which may not be ideal.
Plan to retire at 55? Here's how much you need to save
To see how all these questions work in practice, let’s consider Craig. He earns £60,000 a year and would like to maintain a similar lifestyle after retiring at 55. Using the 70 per cent rule, he estimates he needs an income of £40,000 a year in retirement.
Craig estimates that he’ll live to the age of 80, meaning a 25 year retirement. He also assumes average growth of 4 per cent interest on his pot (which is reasonable, but not guaranteed). If he were to draw out £40,000 per year, he would need £650,000 in the pot initially in order for it to last the full 25 years (it would actually last just over 26, but Craig likes to leave a margin of error).
This calculation doesn’t take into account Craig’s state pension, which he would start to receive 10 years after he retires, but he decides not to include this in his estimates in case he lives a lot longer than he expected.
So if Craig discounts the state pension from his figures, he’ll need to save that pot of £650,000 by the time he’s 55. Can it be done?
How to save up £650,000
If Craig saves from the age of 25 until he’s 55, he has 30 years to build up his pot of £650,000. Again assuming annual growth of 4 per cent (not guaranteed!), a monthly deposit of £925 would build up a pot of nearly that much (£644,136) thanks to compound interest. Assuming basic-rate tax relief of 20 per cent (though Craig will qualify for double that on some of his earnings during periods when he pays higher-rate tax) this requires a monthly contribution of £740.
|Bonus tip: If you're a higher-rate taxpayer, you can claim 40 per cent tax relief on each pension contribution. However, this doesn't happen automatically - you'll need to claim it back from the tax man through your self-assessment tax return. Many people have a backlog of unclaimed tax relief. Are you one of them?|
Let’s further assume that Craig has a good employer who matches every pension contribution he makes. Now Craig himself only has to pay in £370 every month. As Craig earns £60,000 a year (£5,000 a month), that works out as between seven and eight per cent of his income – which sounds perfectly doable.
Of course it isn’t quite as simple as that, as Craig is unlikely to be on £60,000 all of his life. Assuming he might earn £25,000 at the age of 25, that £370 a month would be a whopping 18 per cent of his salary – far more than most people could afford.
|Bonus tip: Make sure your workplace pension is working as hard for you as possible. Your pension pot will be invested in a default fund unless you request otherwise - and this is rarely the best choice for you. You can achieve a better balance of risk and reward by exploring other fund options. Find out more about this.|
How to retire early and not run out of money
Retiring at 55 is tough goal to achieve – but as these figures show, it’s not a completely unrealistic one. By working out in advance what your income needs will be, working out how much you’ll need to save up and then how to do this, you can turn a pipe dream into a practical plan. And of course, you may not even wish to retire so early, or may take part-retirement for a number of years, in which case the dream becomes more achievable still.
The examples given here are simplified, and don’t cover all the variables and uncertainties that are a part of retirement planning. If you want to achieve your own comfortable retirement – early or late! – a financial adviser can give you a fully tailored plan of your own.
Final checklist - tips for early retirement
Here's a quick summary of tips for retiring early:
- Start your pension as soon as possible
- Choose employers with the most generous pension schemes
- Max out your employer pension contributions
- Ensure your pension is invested in the best fund for you (this will change over time)
- As your earnings increase, increase your pension contributions
- If you're a higher earner, claim higher-rate tax relief
- Track down old pensions and consolidate them into the best scheme
- Check all your pension schemes for special benefits, such as guaranteed annuity rates
- Move other savings into your pension pot when near retirement age, to gain tax relief
- Think about and maximise other sources of retirement income
- Consult a financial adviser at least 10 years before retirement
Here are some more useful tips on when and why you should seek pension advice:
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