Making Cents: How much do I need to save to retire?

PEOPLE often ask me how much do they need to save every year for their retirement?

And how big does their pension fund need to be when they retire full stop.

And my answer is always the same - I’m not quite sure.

I’m not sure because I don’t know what their lifestyle is like and how much they’re likely to spend at some stage in the future which could be 5 years away or 35 years away.

Some people might spend €2,000 each month and others might spend €5,000. And obviously those who spend €2,000 will need to save a lot less than someone who’s going to be spending €5,000.

Anyway, to overcome these unknowns, in this article I’m going to give you a formulae that everyone can use, regardless of their age or income level or how much they’ll end up spending in retirement.

And that formulae which will uncover what your end pension number is:

Gross annual salary – (annual savings + state pension + a 25% reduction in your annual salary) x 25.

Before I continue, let me quickly put a value on the state contributory pension for you.

The maximum personal rate payable at the moment is €13,796 and that is where your PRSI yearly contributions average 48 or more.

If you fall into the second band where your average yearly PRSI contributions are between 40 and 47, you’ll get €13,525 per year. And there are four other bands, with the lowest personal rate payment being €5,512 per year.

You’ll see from the formulae that, that I’m suggesting you apply a 25% reduction on the amount you’re currently spending because I believe you’ll spend that much less in retirement. Costs like mortgage payments, transport, children’s expenses etc. are likely to be less, but it’s also true that some costs may go up like healthcare or travel.

I’m suggesting 25% because it’s about the average rate I come across with my clients. And some will see a higher % and others a lower one, but I think 25% is a good number to use.

And there shouldn’t be a need to save in retirement which is why I’m deducting it from your outgoings in retirement.

Okay, let me give you a couple of examples to show you, how you can apply and use this formula:

Example 1
Let’s assume your gross annual income is €40,000 and you are saving €6,000 each year and you’ll be entitled to €13,796 from the state contributory pension, and you’re going to spend 25% less than what you’re currently spending when you retire.
When you account for all of these, your target fund is €255,100.

€40,000 – (€6,000 + €13,796 + €10,000) x 25 = €255,100

Example 2
If your gross annual is €40,000 and you are saving €10,000 per year and you’ll be entitled to €13,796 from the state contributory pension, and you’re going to spend 25% less when you retire, then your target fund at retirement is €155,100.
€40,000 – (€10,000 + €13,796 + €10,000) x 25 = €155,100.

You can see in this last example that saving an extra €4,000 per year, can reduce the amount you need to accumulate by €100,000. Which shows you the more you save, the less you spend, which has the knock-on effect of having to accumulate less.

Being able to play around with these numbers and plugging whatever they are for you, will show you what your target number is, and what you need to be doing in the intervening years i.e. are you on track with the amount you have accumulated and are saving each year?

And maybe you won’t get the maximum amount from the state pension and maybe you’ll spend less than 25% of your current salary in retirement or maybe you’ll spend the same. You just need to find out what both of these numbers are and if you don’t know how to work them out, get help because it shouldn’t be difficult for a financial adviser to uncover them for you.
And it’s really important you find out the answers to both and that they’re accurate, because otherwise you could end up over or under funding your pension fund in the intervening years.

There are two other factors you need to be mindful of, which I haven’t included in the formulae, and both have a bearing on what your end pension number needs to be and the first is, how long you want your private pension to last.
Let me explain.

If you lower the annual withdrawal rate from your fund, it means your fund size has to be bigger because it has to last longer.
And on the flip side, if you increase it, it means the fund can reduce in size because you don’t need it for as long.
The minimum you have to take from your fund is typically 4%, but if you only wanted your private pension fund to last for say 15 years, then you need to multiply whatever your annual deficit is by 15.

If we take the same numbers as outlined in example 2, but rather than aiming to keep it for 25 years, you want to keep it for just 15, then your end number is €93,060.

€40,000 – (€10,000 + €13,796 + €10,000) x 15 = €93,060

If you wanted to keep it for 30 years, then the number is €186,120

€40,000 – (€11,000 + €13,796 + €10,000) x 30 = €186,120

The second factor you need to be cognizant of is whether the annual amount you wish to withdraw from your fund is a net or gross one. I suspect it’s always going to be a net after tax one because you can’t spend what you don’t have, right?

So, you’ve always got to factor in taxes into your calculation, and maybe what you’ll have to pay will be very little if anything at all, it really will depend on how much your total income will be, but it’s something you have to be mindful of, that’s all.

But what about if you have a Defined Benefit pension?

You can still use the formulae.

You first need to convert the amount payable each year into a defined contribution value, and you do this by dividing the annual income payable by 4%.

So, if your employer was promising to pay you €12,000 each year when you reach retirement age, that has a value of about €300,000 because that’s what you’d need to accumulate in a defined contribution pension, when you take 4% from the fund.
Let me give you an example where you have a DB pension.

Limerick Property Watch: Superb home with stunning views

Lets’ say you earn €50,000 and you save €5,000 per year, you’ll get the max state pension, and you’ll spend 25% less than you currently do, and your employer is going to pay you €18,000 per year in retirement.

When we apply the formulae, we’ll get the following:
€50,000 – (€5,000 + €13,796 + €12,500) x 25 = €467,600

The shortfall is €467,600 but the value of that DB pension of €18,000 is worth €450,000 (€18,000/4%) so the deficit in this instance which has to be made up is just €17,600.

Which means you need to consider making AVC contributions to make up the difference.

And if the DB value is greater than the amount you need, then you’re on track and nothing really to do.

Without doubt, there are lots of moving parts but once you plug in your numbers into this equation, you should come up with the amount you need to accumulate.

And once you know what that is, you’ll be able to see if you’re on track to meet it or not.

Liam Croke is MD of Harmonics Financial Ltd, based in Plassey, Co Limerick. He can be contacted at liam@harmonics.ie or www.harmonics.ie