I am in my mid-forties and I have been working for more than 15 years at highly demanding jobs. I met many interesting people, went to places that I wouldn’t have visited otherwise and learnt a lot from the various experiences while going up the corporate ladder. However, it is difficult for me to imagine that I will continue working with this intensity for another 20 years.
When I shared my thoughts with friends and colleagues, most of them responded that even if we want to work until 65 years old, there will be very few jobs for us and these jobs will probably be at a much lower level.
Not to mention that due to the challenges that pension systems in different countries already face, the retirement age will keep increasing and the amount of money we will receive will keep decreasing. Hence, we should not assume that if we do what our parents did, then everything will be ok.
Since we will have to work much longer than previous generations, how can we can get better prepared for the future?
Good financial planning is key to success. The basic concept is very simple. While we are working, our salary (usually) covers most of our expenses (e.g. mortgages, food, clothing, vacation etc). When we will retire though, we want to ensure that our pension (state & private) plus other sources of income are sufficient to cover our expenses.
The earlier we start acting, the better it is.
It would help to do some “back of the envelope” calculations before deciding how to act.
- Calculate how much money you will need to live when you will stop working at retirement. Write down the key annual expenses; especially the big ticket items e.g. mortgage payments/service charges/rent/private health care insurance/car insurance/food etc). You can also add an amount for the ‘nice to have’ items e.g. vacation, hobbies etc. This would help you to get a rough idea how much money you will need on an annual basis a) for the basics and b) for a more comfortable lifestyle.
- Estimate how much money you will receive after your retirement. The key sources will be your pension (both the state and the private one). You probably have a good understanding of the state pension level in the country you live (For example, it will be around £150 per week or £600 per month in the UK). For the private pension, you can usually get an illustration from your pension provider. Otherwise, you can do the calculations yourself. A good ‘rule of thumb’ is to estimate the pension pot you will have at retirement age and then divide it by 25 years life expectancy and get a ball park of the annual private pension. (For example, if your pension pot when you become 65 years old is £350K, then you may expect £14k on annual basis.)
So let’s take an example:
Kate is 45 years old and her annual salary is £70K. Her current pension pot is £100K. Both Kate and her employer contribute around 10% of her annual salary to her pension pot. If we assume that she will contribute for another 20 years, her pension pot would be £240K at retirement age (10%*£70K*20 years = £140K +£100K her current pension pot = £240K (Note that we didn’t take into consideration the possible growth of the pension funds depending on Kate’s investment decisions for the sake of simplicity). If we assume a 2.5% growth for the next 20 years, then the pension pot will increase to £335K.
The £335K pension pot translates into £13.4K every year (£335K pot/25 years=£13.4K). If you also add £7.8K from the state pension (£150 per week* 52 weeks = £7.8K), then the total amount from pensions that Kate will receive after she reaches the retirement age will be £21.2K approx per year.
Note that the income that Kate is expected to have from her pensions at retirement is 1/3 of her current salary. So, her living standards will have to be adjusted accordingly.
My suggestion is for you to do a ‘back of the envelop’ calculation based on your personal circumstances. Keep these calculations simple. It is not necessary to include inflation/growth of investments & taxes. All these definitely will have an impact. However, it is very difficult to make predictions when the time horizon is 20 years or more. The whole point of this exercise is to get a feel of the big picture i.e. what is the gap between your income after retirement age versus the outgoings you expect to have at that age.
The bottom line: Even if you are surprised by the outcome of this exercise (and trust me you will!), it is better to know the gap between the pension money you will receive and that you would need to have a comfortable lifestyle after retirement so you have time to make the necessary corrective actions.
At the next blog post, we will discuss what we can do to get better prepared for the future.
(If you want to get financial advice tailored to your needs, please find an authorised financial advisor in your country. This blog is to help you understand the situation you will face and encourage you to do something about it now.)
Korina Karampela is the founder of b4iapply . She passionately believes in empowering people to make informed decisions about their career and their finances. She is a senior executive in the pharmaceutical industry and has an MBA from MIT Sloan. In her limited spare time, she provides pro-bono career advice. Her b4iapply blog is recommended by The Guardian for professional development.