Can YOU predict your future financial needs?

I’ve had a few days to let my numbers sink in now. That’s since this happened. I knew I had some savings. I knew I had a relatively generous pension. I was knee-deep in researching SIPPs to divert my savings tax-efficiently* into passive tracker funds that are inaccessible until 57 years (for me anyway). Tax efficiency was the major incentive. 57 sounds an age away.

Since seeing my numbers as stark as day, I’ve been wondering why I’d not calculated my key figures before. I’d been so stuck in the granular detail of current investment, I hadn’t considered that it’d be worth trying to work out my precise net worth and assets (granted, certain assumptions had to be made).

FI is too far away, I thought. I was nowhere near the £325-400k that I needed (£13-16k assumed living cost x 25) to live off capital growth in investments… And I’d have been right about that! We’d focused on paying off our mortgage over the last few years and this is not ‘investable’ into market indices, so not included in the ‘x25’ calculation.

Yet strangely my asset total is in that range already, above £414k. (I better not think about it too loudly in my head for fear of some random person overhearing. :P) How I achieved this in my early forties on a high-end basic tax rate salary is a topic for another day (soon), but the simplest answer is that I nearly always saved whenever I earned anything.

I don’t have to make any decisions as yet about when I start Path 2, and it makes sense that retirement at 57 is entirely feasible, and some years earlier if I don’t want to make any unexpected large purchases. However, what I do need is a new investment strategy. My immediate thought is U-turning on buying a SIPP (a private pension that can be invested ‘tax-efficiently) in the stockmarket to the fund etc. of your choosing), as I wouldn’t be able to draw on it until at least 57, when I think I’ll already have enough, as calculated here.

Ways to consider how much you’ll need at 57+ years

But wait a second, I could be making a Pensions 101 schoolgirl error by underestimating how much money I require to live comfortably. Which I already felt certain about here. There’s a decent probability I am just because of how human psychology works (I think), but it’s so hard to know! A few things are easy to predict: On Path 2, I won’t pay for work lunches anymore. By that time, we won’t have childcare costs anymore. These are significant recurring costs.

But will I want to eat out and go away to the level we do now when we’re 57 or 63? What about 70 or 85? Who knows?! I may well value private health insurance by then and want to spend 3 months of the year in sunnier climes.

Let’s consider how people might commonly work out how much they need in ‘earlyish’ retirement (perhaps one of these is you?):

(1) Assume your costs will more or less always be the same; (2) Project yourself into what you think is typical spending in each age group – e.g. minus work-related costs and adding golf/health club membership. (3) Look at the spending of current pensioners.

Let’s take a closer look at each one…

1) Assuming you’ll always have the same level of expenses sounds like a dangerous assumption. But we may think that we’ll swap one cost for another as our needs change and there’s likely to be some truth in that. Having seen our lifestyle change since having Little Firelite, it wouldn’t be a surprise if my future lifestyle is somewhat different from how I imagine in ways I can’t fathom now. Will I end up wanting to join a decent health club year-round? Will the NHS severely limit what medications they’ll fund by then? Health and holidays are probably the biggest unknowns for me. Okay, excepting certain circumstances, our spends will probably ‘naturally’ continue to be ‘fairly frugal’ relative to our peers. So, costs may not remain the same but would probably be less than what many others spend.

2) On the one hand, you may think that the 57-67 year age group are still fairly active but do things that don’t cost much money, like um look after grandchildren, go for long walks, focus on community activities, free or subsidised classes at the local leisure centre and college. They may do a nice all-inclusive once a year. So, we’ll spend less as we get older, because the kids have left home, you’re not paying the mortgage anymore, and such like. But, we’ve already paid the mortgage. Also, time not in work may be replaced by activities that cost.

This may be a controversial statement, but I do also half wonder how much of this assumption reflects a subconscious bias in younger society that devalues the (consumer) needs of the older generations. Somehow by that age, “I’ll make do”. Er, actually comfort and peace of mind may be much, much more valuable than we can appreciate now. Relatedly, it’s also inconvenient for FIers to think we may have high unknown costs as we get older. So, there may be a tendency to brush this under the carpet a bit. For all of these reasons, I don’t think my/our costs will decrease substantially.

3) Perhaps a better way is to see what the average pensioner today spends. Sure, the vast majority of pensioners are older than the age range I’m focused on in this post (57-67), but could be interesting nonetheless. Based on a survey this year of 6000 retired and semi-retired Which? magazine members (which must have generally middle class values, one would think, right?), the average household was found to spend £27k a year (£2200pm). Travel/hols are viewed as very important, with the average spend of £4,800. For a single person, a comfortable lifestyle is something like £20k. So, if I split the couple cost for myself, it’s £13.5k. Conveniently, I pretty much costed this amount (13k) but the £16k was adjusted for inflation.

Still, looking at the survey more closely, some of the costs seem high next to my own current lifestyle, such as transport (£2358) and clothes (£1013) to maintain what they refer to as an ‘essential’ lifestyle. That’s interesting. Housing cost would be zero for us, and groceries come out as the largest spend at £3948pa (£76 a week), which may be higher than what we spend, but that’s likely to be due to eating out of the home a lot more than we do now. Our current transport spend must be under £1k using public transport and occasional taxis, though not sure how this would change when we downsize out of the city.

Analysis by the Dept of Work and Pensions in 2017-18 shows that the average couple has an income of £23,608 a year (£11.8k each), so Which? subscribers are unsurprisingly more well off than average. Note that these are stats on income while Which? asked about spending.

Looking to my own parents, they pretty much ‘make do’ on their state pension, but they hardly eat out or go on holiday. If they had more income, maybe they’d holiday more, but even if they say that, they are pretty much the home bird type. Health issues don’t make it easy. They certainly wouldn’t eat out much more even with higher income, since the health issues are partially dietary. I’d say I’m definitely looking for a more active lifestyle than theirs.

Going by what we know about current pensioner spending, it reassures me that I’ll have enough to live on at conventional retirement age, and somewhat confident in the 57-67 age range, when I’m likely to be more active. At the end of the day, I hope I’ll still be doing something productive and authentic to my values, and that sometimes requires money!

Also, inflation is a messy subject we can’t totally ignore, but very difficult to know how to take into account. There’s official inflation based on a ‘rigged’ basket of consumer products, then I also consider an unknown ‘true’ inflation. How much do you try to figure into inflation can really mess with your figures! Costs may inflate at a faster rate in future if oil prices go up loads, or could remain stable if biofuel technology becomes cheap enough to mass produce. Costs may inflate (or deflate) disproportionately for those things we don’t buy (if we’re lucky), but what’s almost certain is that food and fuel will become more expensive.

So, what do do?

Overall, we can only go by our best guess given all these sources of information and what we know about our own personal tendencies (e.g. lifestyle choices) and potential biases (to underestimate future spend). We can also include a pot of reserve savings, that could take the form of a SIPP or other saving, which would be over and above any emergency funds.

If I put £10k into a SIPP, Vanguard’s pension calculator estimates I’ll get a £430pa (£35.83 per month) pension from this (presumably from buying an annuity). Hm. Since I only ‘need’ this fund for 10 years, it’ll be less costly to have a single reserve pot of savings rather than an annuity. To factor in a 20% increase in my anticipated spend, this would require £32k of savings (unadjusted for inflation). So maybe a good option would be to stick this 20% contingency fund into a SIPP (which gets tax relief) as I have over ten years to make it grow.

However, if I take this pension (SIPP) out as a lump sum (I think I’d want it as a lump sum, right?), only the first 25% would be tax free… while as an ISA, it’d all be tax free. but an ISA has an investment maximum of 20k each year (and no income tax relief at purchase). If I do take next year out of paid work, I can use next year’s ISA allowance to build a good portion of this contingency fund. 🙂 Also, SIPP tax relief is more limited when you’re not working (understandably), so if I want to apply for a SIPP, I should do that this year.

How have you costed for this period known traditionally as early retirement? If you’re keeping to investing in passive fund / bond splits, will you still feel secure doing so as you enter your 50’s?

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*SIPP tax efficiency actually means that 20% of what you buy is added to your SIPP by the government if you’re a basic rate tax payer, and the same if higher rater with additional relief through filing in a tax return. There is also tax relief at the point of withdrawal of the first 25% of a lump sum, but not if you buy an annuity which allows a regular income.