Setting a savings target for retirement is really hard for most people because the figures are all guesswork.
Few of us really know how much we will spend on day to day bills and no one knows how long they will live after giving up work.
Few of us are likely to have accurate amounts to hand showing how much was spent on food, heating or the car in the past year, so projecting 20 years or more ahead is even more difficult.
Retirement is a financial as well as a social milestone.
The big day marks the time when saving stops and spending any money amassed in the bank, pensions and any investments starts providing an income.
With these lifestyle and spending variables, how do people decide how much to draw from their savings each year?
Pension providers and investment houses often publish studies into the topic.
Financial balancing act
One of the leading thinkers among the first to consider what financial advisers call a ‘sustainable withdrawal rate’ was William Bengen.
A sustainable withdrawal rate is basically the money someone can take each year from their savings and investments without depleting their capital.
It’s a balancing act between spending money and hoping the rate of return on the remaining investments will generate enough cash to replace what you have taken.
In the 1990s, when Bengen published his theory, he calculated taking 4% of capital a year would match the investment return.
But the markets were giving better returns then, while interest rates were higher and bonds generated much more than now.
People are also living longer.
Most men are expected to live 18 years after retiring at 65. Women are given 20 years in retirement by actuaries.
Married men are also likely to want to leave enough money to ease their wife’s finances when they have passed on, which means they need more than they will spend.
According to Bengen’s Law and assuming a retirement pot has to last 25 years, the yield on investments needs to hit at least 4% a year every year.
On a money pot of £200,000, that is drawing £8,000 a year over 25 years.
Taking the cash is easy enough, but putting £8,000 back every year on the current performance of the markets is a challenge to say the least.
No good hoping for the best
The investment return now is much lower than 30 years ago – nearer 2%.
The problem is also how much does someone need to save each month to build a nest egg that supports the amount they need to withdraw in retirement?
That depends on a saver’s age and disposable income now and how long they have to put the money aside.
Working out all these variables shows most of us need a retirement plan based on sensible figures or running out of cash too soon after leaving work is a real possibility.
Discussing retirement goals with an independent financial adviser can help set reasonable and achievable saving targets based on realistic assumptions.
It’s no good plucking estimates out of the air and hoping for the best.