You have worked really hard over the years and have accumulated a pension pot of £100,000.
That’s awesome, how much retirement income will that give me: around £4000-£5000 a year.
What? A year?! There is no way. How can this be and how do I increase my retirement income:
People don’t realise that a £100,000 pension pot is equivalent to an income of £5000/year.
This is calculated by taking 5% of your total pension pot i.e. 5% of £100,000 is £5000/year.
This income is achieved by using an insurance product (annuity) or manually withdrawing.
To achieve a yearly income of £50,000 a year, you would need a pension pot of £1 million.
In this blog, I talk about when to access your pension and how much you can take out tax free.
I also discuss your different income options: picking an annuity or manually drawing down.
Finally, I mention how much you would need and how to be on track to save up that much.
25% Lump Sum Tax Free
The size of your income in retirement depends on how you decide to access your pension pot.
For example everyone is entitled to take 25% of their pension pot tax free at retirement time.
That’s right, your pension pot is taxed, just incase you thought that all the money was for you.
Oh, and you can’t access your pension pot before age 55 – even if you wanted to retire earlier.
So if you have a pension pot of £100,000, then you could withdraw a total of £25,000 tax free.
Most people choose to do this: they want to pay the rest of their mortgage or buy a new car.
However, there is a disadvantage to taking this lump sum, as I explain in the next paragraphs.
If you are buying an annuity, you would want your pension pot to be big to have a big income.
If you’re manually withdrawing, you would want your pot to be large to increase your income.
However, you can decide to take out £10,000 and leave the rest for your retirement income.
Option 1: An Annuity
This is an insurance product you can buy to get a guaranteed income for the rest of your life.
The level of income that you receive will depend on the annuity rate at the time of purchase.
For example, if annuity rates are 5%, then you will receive 5% of your pension pot each year.
So a pension of £100,000 would buy you an income of £5000 per year for the rest of your life.
I don’t know about you but this does not excite me – is there any way to increase the annuity?
There are ways to increase your annuity, but they are not the most exciting options either:
One way to increase your annuity is if you have a serious health condition – well that’s nice.
The other option is if you keep working for longer, past 70 for example – also not a great option.
So if you want to retire early and are in good health, then around 5% income is your annuity.
That’s unfortunately how these companies work – they want to pay you as less as possible.
Option 2: Manual Withdrawing
Your alternative option is to manually withdraw a given percentage from your pot each year.
This refers to the early retirement principles that I talk about which you can read about here.
The Trinity Rule states that withdrawing 4% of your pot makes your money last for 30 years.
We also know that inventor of the 4% rule says that this is now the 5% rule based on the data.
So similar to an annuity, 5% of £100,000 means that we could have a yearly income of £5000.
There are some advantages to this method, such that you can withdraw as much as you want.
You can withdraw more money per year to adjust for the increased cost of living i.e. inflation.
Another advantage is that if you are invested in index funds, they pay you an annual dividend.
That means you already get an income, you just have to withdraw to make up the rest needed.
Therefore if you trust yourself to follow the rules, manual withdrawal might be a good option.
How Much Should I Actually Save?
Having read this blog so far, you’re now familiar with the ways of having a retirement income.
However, that does not address the key concern: how am I supposed to live on £5000 a year?
That’s the equivalent of £417 a month. Are you telling me after all these years this is all I get?
Unfortunately, that is the reality if you only have a pension pot of £100,000 income retirement.
However, you may be reading this and still have a long way until retirement, which is great.
Because this means that you have plenty of time to make sure you save the correct amount.
Let’s say you want an income of £50,000 a year (£4,167 a month), you would need £1 million.
£1 million pension pot? That is a lot of money, how am I supposed to accumulate that much?
By contributing more to your pension: I don’t mean £200 a month, more like £1000 a month.
As you can see in the image above, that is the reality if you want that amount in say 20+ years.
Why Has No One Told Me This?
We work for our employers thinking that if we work hard, we will be sorted for our retirement.
However, no one ever sits us down and asks us if we are investing enough for our retirement.
Why? Party because our employers don’t really care; they just do what they have to do legally.
The other reason is because they are not aware of it themselves, they just assume it is alright.
No one tells us that to have a comfortable retirement, we should be saving half of our income.
This is the mission of Mind Your Business: to make sure people are prepared for their future.
To find out more about retirement planning, then check out the book Quit Like a Millionaire.
In this book, the authors talk about how they saved enough to not only retire, but retire early.
Are you saving enough for a comfortable retirement? Please share in the comments below.
If you want to find out more on retirement planning, please let me know in the comments.
