How Much Should I Save For My Retirement?

bigbloke45

Well! This is getting “interesting” (OK, please pardon the pun!)

I posed the original question to get an idea as to thinking of the respondents. What is coming through, I believe, is that this is a complex area for many people because of the maths involved.

What I want to do is to show how you can build a model using a simple calculator and, if necessary, a pen and paper in order to estimate how much pension contribution – as a percentage of today’s salary – you need to make to achieve the fund you have also calculated that you will need to build in order to retire on a reasonable private pension. All I ask is that you know how to use the power function on your calculator..

The ONLY number that really matters in these calculations is the difference between your assumed rate of investment growth and the assumed rate of future salary growth. It really doesn’t make a lot of difference which numbers you choose; e.g. fund growth 10%, salary growth 8% will give you very nearly the same percentage contribution as using 5% and 3%. Also trying to be too precise is foolish. Even governments, with all the resources at their disposal, can’t really forecast more than a few years ahead.

I am using a £2.00 “Texet Scientific” calculator I bought in Tesco’s the other day (to keep in my pocket to check out things when I’m shopping).

So, here goes!

To calculate a fund based upon a percentage contribution increasing in line with salary growth and then to calculate what percentage of today’s salary is needed does, as rathga points out need to involve an increasing annuity calculation but, there is a short cut that gives a result that is near enough without all the complicated maths and can be done in a number of simple steps. You don’t have to do the steps in the same order as me, just record the answers as you go along to get the final result

Step 1. Calculate your Final salary as follows,

Today’s Salary X (1+ Assumed Salary growth/100^No. of Years to Retirement)

I’m assuming a Salary of £10,000 (in order to adjust later) , a salary growth of 5% ( it could be any number you like) , 30 years to retirement.

So, 1.05^30 = 4.322
4.322 X £10,000 = £43,220 your Final Salary

Step 2.

Calculate what Fund you need to achieve your desired pension.

This is easy! Assume an annuity rate, say 5% and work out how many pounds fund are needed to buy £1.00 of pension. For 5% the answer is £20.00. This is the COST of your pension. You need to multiply your desired pension by this figure. The calculation is 1/0.Assumed Annuity rate. Here it is 1/.05=20

Next multiply your desired pension by the cost of your pension. Let’s assume 40% Pension at retirement is OK because you have other assets/inheritances etc. as well.

So, the projected salary of £43,220 X 0.4 = £17,288. The fund required is therefore 20 X £17,288 = £345,760

Step 3.

Assume a Contribution Rate and multiply by the Final salary and the number of years to retirement. I’m assuming a 1% contribution Rate (which will be adjusted later to find the required one, I promise!)

£43,220 X 30 X .01 = £12,966

Step 4.

Multiply the answer to step 3 by 1+(Assumed Investment Return Minus Assumed salary Growth) to the power of the number of years to retirement divided by 2. (What this does is to take an average of all of the accumulating bits of an otherwise complicated process!) I’m assuming an Investment return of 7% for argument’s sake.

So, £12,966 X (1+ (7%-5% )^(30/2)

i.e. £12,966 X (1.02^15)

1.02^15 = 1.346.

Times this by £12,966 (i.e. 1.364 X 12,966) = £17,452

Recap

Where are we now?

What we have done so far is to;
a. Calculate a final salary
b. Calculate the required fund needed to produce your desired pension
c. Calculate the Approximate fund produced by a 1% of salary contribution assuming a 7% fund growth and a 5% salary growth

What we need to do next is to calculate the Percentage of today’s salary we need to contribute to achieve the fund we need to get our desired pension.

This is easy, all we have to do is “pro-rate” the two funds and multiply the answer by our 1% initial assumed contribution rate as follows;

£345,760 / £17,452 = 19.8 Thus the required contribution rate is 19.8 X 1% i.e. 19.8%

Wow! That is a very high contribution rate but remember it is based on the assumption that there is only a 2% difference between assumed fund growth and salary growth and an annuity cost of 20. The H-L pension calculator uses a 6% growth assumption and a 2.5% salary escalation and a single life annuity rate of 6.5% or 3.5 for a half widows pension if I recall. You can use their calculator to work out how much you need to contribute as a percentage of salary (on their assumptions, of course) by seeing what percentage of final salary is produced by, say 5% contribution and then pro-rating the % pension over your desired pension and then multiplying the 5% by the answer (it could be LESS than 5%, but I doubt it!)

Rathga, your model is precise, but I think you need to multiply the fund you calculated by (1+i) to get the result for an annuity due i.e. a payment in advance calculation. Using your formulae, corrected to payments in advance, the “correct figures would be a fund of £345,744 and a percentage contribution of 19.6%. so my little “fudge” is fairly accurate!

The formula I’ve used is;

(Salary X (1+(Salary Growth/100)^Term) X (Contribution rate/100) X Term X (1+(Investment growth – Salary Growth))^Term/2

But my main point is that it was all done on a £2.00 Texet calculator! If you break the formula down into simple steps and do a bit of pro-rating it’s easy!

!!!!!! here, I'm NOT trying to be patronising, I'm trying to give those who are interested a simple way of calculating how much they need to save for retirement.

Retired IFA, I don't think you need to get involved with mortality tables and long gilt yields, actuaries get paid a lot for this; so I would just look at current rates (it's only a model, after all!)

I really believe that we all owe it to ourselves to be able to do these calculations otherwise Government and Big business will pull the wool over our eyes. Just use the above to work out how much it costs to fund a MP's pension!

I look forward to hearing your comments!

bigbloke45

Robin_T_Cox, I think you are right about investment professionals; Dithering Dad took me to task about being too negative about this. But I think you are missing the point when you advise that "you should save as much as you can reasonably afford".

That doesn't give anyone an idea as to "how much" they should be saving for retirement. That's why the "fancy formulas" or "complicated calculations" are all about; it doesn't matter what the underlying maths are complicated, what does matter is that we should be able to plan ahead using reasonable assumptions as to the future. Things will change, so we go back and re-jig our models. What we must never do is rely on putting away as much as we can reasonably afford. As a young man I couldn't afford to reasonably save for retirement at all. So, saving nothing would not have been a great help, even if was reasonable

Now your'e retired, why not invest a bit of time in getting to grips with financial maths? You mihgt be able to help someone younger.

fimonkey

WOW, thanks BigBloke, and that's simple?

I'm almost embarrassed to ask this question (shows how weak my maths is).. but what does the 'arrow up' symbol mean? (Grr can't find it on my keyboard). .. Is it multiply? (as in here) 1.05^30 = 4.322

Retired_I.F.A.

It means To the power of.

For example £100 today at 5% interest in 20 years will have a value of :

100*1.05^20 = £265.33

If inflation over that time has been 3%p/a then it will have the buying power today of:
265.33*1.03^-20 = £146.91

Assuming the real value today of an investment of 100 at 2% (the difference) for 20 years to be 100*1.02^20=£148.58 is the wrong way to calculate it as compound interest does not work that way.

bigbloke45

fimonkey, the power symbol is over the "6" key but don't worry, it's just a convention. As I said in my post, I did all of the calculations on a £2.00 Texet calculator from Tesco's. On your calculator you will have a power function as well. All I was asking is that people know how to use it.

If you follow my steps, you will arrive at an answer that will be a very close approximation to rathga's correct formulae. If you think about it, you don't need to be that precise, it's only a model! But what it does is to give people the freedom to plan for the future. You can change the assumptions as you see fit. As I've said the most important number is the difference between your assumed rate of salary growth and tyhe assumed rate of investment growth; the wider the margin, the lower the contribution rate that is needed, it's your call!

I really have tried to break down the process into manageable steps. If you do one at a time, I hope you will get an insight into a rigorous financial planning process that will help you in your endeavours. As I said, it's all about assumptions and the ones that the FSA tells people like H-L have to use are really no better than you can come up with providing you are being reasonable.

So, please persevere with this. It will give you such an advantage, I promise.

Retired IFA, you are absolutely correct in your assertion, the right way to calculate the present value of a future sum, adjusted for inflation, is to first calculate the future value and then the present value. My point is that the answers aren't that different, hence my "fudge" equation, but the main point is to provide a simple way to do the maths to get close to the real answers. It's only a model!

Many years ago,I used to calculate future values to the nearest pound! What a donkey I was! Now I believe that orders of magnitude are better, just to give a taste of what the future might hold. BUT, you need to do some calculations to get an idea and, for that, you need to use compound interest.

We don't all need to be geniuses for this, they've already done the donkey work, we just need to be able to take what's given and use it for ourselves!

Good hunting!

Retired_I.F.A.

Big bloke.. I've wrote a spreadsheet these last couple of days that does compound interest including escalating contributions using it to answer firmonkeys dilema actually maybe you could be of help I've forgot how to use the hlookup and vlookup function. if I can suss that I can finish it off and get it hosted somewhere perhaps.
If you can help gimme your email addy and i'll post it to you.

bigbloke45

Retired IFA, I'm not that good at excel, but this link might help, it's from MS Office website for Excel 2003


http://office.microsoft.com/en-us/help/HA010563201033.aspx

I'll send you my email address.

regards,

BB45

Retired_I.F.A.

I Spent an hour or two looking at that the other night and still could not suss it.
The answer is dead simple but not having used it in years i just cant see it now.
Hope you can suss it for me I've just sent the sheet to you. Cheers.

bigbloke45

Retired I.F.A. thanks, I'll have look. Have to say I just love your Andy Kapp logo.

I think I'm going to have to come up with something better than mine, it's just my grand daughter's teddy hanging out to dry, but it just seemed to encapsulate how I felt at the time.

Retired_I.F.A.

Andy Capp sums me up pretty good really.
We first came into this world at the same time Andy first appearing in the daily mirror as me mum went into labour. I've got a cloth cap attitude though my cap is a bit old now the landlord moans about the moths flying out when I take it off. Either Reg Smythe or Flo made him pack in smoking wheras I took the easier route and got a divorce and of course we both love playing snooker beer and wenching, what man doesn't?
:beer: