When to give up or take a step back from work often involves a difficult judgement. It’s also a common enquiry financial advisors receive. Working out whether someone can retire early requires an in-depth knowledge of a person’s situation and requirements, as well as some complex calculations.
What does retirement mean to you?
Retirement means different things to different people, but for most it represents financial independence, the ability to live off your own resources without having a job to support income needs. Achieving this early tends to mean before normal retirement age in mid-sixties, but situations vary. Successful businesspeople, for instance, may have the resources to bow out significantly earlier, while some careers such professional sport can be high earning but necessarily end much sooner.
In the initial stage of retirement, it’s often about enjoying life to the full and ticking things off the bucket list. Expenditure may then drop as you wind down and become less active, but then increase again, perhaps as care needs rise later in life. Lots of people end up overestimating their health or underestimating their longevity. As life expectancy increases, the average time spent in retirement is nearly 20 years – more than double that of our grandparents. But, like many things in life, it partly comes down to chance.
In simple terms, full retirement means that your outgoings over the rest of your life must not exceed your income plus your remaining resources in the form of savings and investments. That’s a hard computation to make in many cases. You will need to consider your pension and other income versus your expenditure and varying needs as you age.
At the same time, you need to consider investment returns and the impact of inflation – rises in the cost of living. As we are seeing at the moment, everyday prices can move upwards at quite a pace and rapidly erode the spending power of a fixed income or cash savings.
Getting the foundations in place
Before you consider early retirement, you need some building blocks in place in order that you have the opportunity to meet your needs and reach your goals.
Paying off any debt and repaying your mortgage (or being close to doing so) is a prerequisite, and you will have to secure enough income for your daily needs from your pension or other investments. On top of that you’ll want income or savings from which to draw in order to enjoy life. Importantly, you’ll need to keep a contingency fund in cash and on hand in case of emergencies.
How much do you need?
Research has found that a couple will need around £17,000 a year to cover ‘essential’ outgoings, such as groceries, transport, utilities, insurance, clothing and healthcare. Add on holidays, hobbies and eating out and most households will need £20,000 to £30,000 a year, a sum that may need to rise over time in order to accommodate price rises.
You will need to factor in your changing lifestyle. For instance, travel costs might come down as you are no longer commuting to work, but household bills and some other expenditure might go up. More free time often means more chances to spend money! Try and work out how much expenditure you will need as a baseline and how much you would like on top for luxuries.
Know your pension rules and regs
An important step is to add up all your pension and other income to see if that can meet your needs.
You can take benefits from a personal pension at 55, though that is rising to 57 in 2028. For workplace schemes there can be different rules, so you need to check what is possible with your scheme administrator.
The public sector still offers pensions in retirement based on your salary, though in the private sector such schemes are rarer. Taking early retirement from these, if it is possible, will mean accepting a lower income.
Many companies now offer employees a pension based on what you and they contribute, rather than linked to salary. This means that you are dependent on investment returns and need to keep an eye on the investments in your pension, as well as decide how you want to take the income when you retire. Retiring early means drawing on your pot sooner and that your money has to last longer. If you’re forced out of work through poor health, you’ll often be entitled to take benefits from your private or workplace pensions regardless of age.
As far as the State Pension goes, this is payable when you reach your State Pension age. For people retiring today that’s 65 but it is rising to 67 by 2028 and 68 after that. The full new State Pension is £179.60 per week, and you’ll need to have paid or been credited National Insurance contributions for 35 years to receive the whole amount. You can get a State Pension forecast on the Gov.uk website.
As well as pensions, you may have other resources with which to generate an income such as investments, perhaps in the form of tax efficient ISAs, or investment property. All of these can contribute towards your meeting your needs, but it’s important to plan carefully how to take income from different sources to ensure your affairs are as tax efficient as possible and to cater for any other objectives such as inheritance planning.
Pension calculations made easy
To assist you with your planning, our pension calculator aims to provide an indication of the additional monthly pension saving needed to fund any shortfall in your required income at a selected age. It takes into account your existing funds and you can experiment with different retirement dates.
You can also see the effect of adding a one off contribution to your existing pot by increasing the size. Remember, pensions are often the most tax efficient means of saving towards retirement, and considerably so for higher rate taxpayers, though remember benefits depend on individual circumstances and could change in the future.
Early retirement can be costly – and advice can be invaluable
Retiring early can place significant strain on your finances. Every year of earlier retirement means an extra year of spending, a year less of earning and potentially less return from any investments you draw upon. That’s why it needs to be very carefully considered.
What’s more, choices made at retirement, and during, can make a big difference to the income you can expect. For pensions in particular, decisions can often be irreversible and making the wrong choices can be costly.
If you are uncertain about which options are suitable for your circumstances, take appropriate regulated advice or guidance. Pension Wise, the Government’s pension guidance service, provides free, impartial information to help you understand your options at retirement, or discover more about our Foundation Planning Services by visiting our hub.
Nothing on this website should be construed as personal advice based on your circumstances. No news or research item is a personal recommendation to deal.