Saving for Retirement (part 1)
Forward to part 2, part 3
As I've been gradually looking into my finances, the biggest question I've had to look at is: how well am I doing in saving for retirement? I've accumulated a number of pensions from my past employers, who all send me statements which I tend not to read. Why not? Because I can't be bothered to unpick the assumptions they've made about growth and whether they're showing me today's money or retirement time money. Then I have savings, and equity in my house. How do I turn that into something I can actually use to help me understand what's likely to happen.
Fortunately, I read a paper from the Institute of Actuaries called Family Fortunes [pdf], from which I've freely cribbed a central idea: you should aim to make your real disposable income to stay constant over your lifetime. Using that, I wrote a spreadsheet to model what that actually implies. The paper I mentioned has its own version [zip], which is probably better than mine, but I understand mine so it's easier for me to fiddle with it.
So the way I did it was this:
- I worked in today's money. That actually makes things a lot easier - you can see what the retirement income actually means. It's pretty easy to scale it up by compounding inflation on afterwards. The key thing you have to remember if you do it this way is that you ignore anything that's inflation related. Basically that just means not factoring any cost of living raises into salary assumptions, and reducing savings growth by the rate of inflation.
- I assumed that there'll be no changes to my status until I retire at 65 (I can't see it being any earlier than that). Already, you can object to that on various grounds - my salary might well rise before then. Or I might get to 50 and be unable to find another job because of ageism. Or my pension fund might be stolen. Yeah, yeah, any of those things could happen, but by modelling the "nothing changes" case, it makes it easier to see the impact of various good and bad alternatives.
- I looked at what I can realistically save each year (no point fooling yourself about this - if you're saving only £100 a year at the moment, then that's the number you should use). This is just ordinary saving - I'll look at pension saving in part 2, but it's not much different. Another key point I got out of the family fortunes paper is that this number is not flat over time. Pension companies often give you a "you should save x per month" figure which seems wholly unrealistic because they assume you have the same amount of spare money at all times. The key thing that changes is that in 18 years or so, I'll have paid off my mortgage. I've assumed that I save all that money thereafter (remember - constant real disposable income over time). Of course, it would be better to save it now, because of compounding, but I could only do that by stretching the family budget to breaking point.
- Put all that information in a column with your current (long term) savings at the top. Multiply each years figure by whatever growth rate you're assuming (I've gone with 2% which is about what I get on savings after subtracting inflation) and add on the next year. Repeat until you are retirement age. See the attached sheet for details.
I've attached a version of this with pretend numbers as a Numsum spreadsheet below. In part 2, I'll look at pension savings, and other things you might want to take into account.
Posted by MFreestone at April 19, 2006 09:57 PM