As of 2015, the average salary in the UK was £27,600. Most people hope or expect to have an annual income of £12,590 after they retire. That is what they believe they can comfortably live on after retirement.
First the bad news….
By the time most people reach middle age, they have typically built up private retirement savings and investments worth £53,793, according to a study by pension giant Aviva.
This pension pot would only ensure them an estimated £3,327 guaranteed annual income from an annuity, or £3,635 if they put their money in an invest-and-drawdown scheme for 25 years which means the average Briton is way way off their retirement goals. Some of this gap is plugged via the state pension, assuming people have made enough National Insurance contributions. The current state pension is around £6,000 a year but will increase for some to £8,000 a year as of 2016.
Now the good news….
It really isn’t difficult for the average Briton (earning £27,600) to retire a millionaire and enjoy a very comfortable retirement for however long they may live. It doesn’t take luck, advanced knowledge or any high risk strategies. It just requires discipline and some very basic investment advice. Here’s how it works……
Lets assume that by the age of 25, you’re earning £27,600 annually. This provides you with an income of £2,300 per month before tax. Now you need to set aside around 19% of your gross income (£445) and put it towards retirement.
Invest that £445 in a tax efficient personal pension plan or SIPP (self invested personal pension). From there, select a conservatively managed index tracker fund that tracks the FTSE 100. It’s that simple.
You don’t have to do anything fancy like day trading or stock picking. You don’t have to buy and flip property or chase the latest get rich quick scheme. You just follow the stock market through a low-fee index tracker fund that tracks the FTSE 100. This gives you access to the 100 of the largest publicly traded companies in the UK.
Let’s assume your money will grow at 8 percent annually. That’s a realistic estimate – the excellent HSBC FTSE 100 Tracker has achieved over 90% returns in the past 5 years. Companys stocks have historically grown at a rate of about 8 percent to 9 percent annually. However, the precise number varies depending on which range of years you’re looking at, so we’ll assume an 8 percent annualised average as a realistic estimate.
Continue to contribute £445 per month into this fund every month. Don’t withdraw it; let it stay in the market. It will reinvest its own dividends and capital gains. You’ll reap the benefits of compound growth. After 35 years, this will grow into just over £1 million.
In other words, if you invest from the age of 25, you’ll be a millionaire by the age of 60. Think about that for a second! You can earn around the UK average wage (£27,600 per year), save 19 percent of your gross income, and retire a millionaire. Just £445 per month, invested conservatively over 35 years, with an annual growth of 8 percent, is powerful enough to change your life.
That’s fairly remarkable given the average Briton has only £53,000 in their pension pot.
With £1m in your fund you’ll be able to live off the annual profits without touching your nest egg. 8% of £1m will give you an annual income of £80,000 which will make for a very comfortable retirement.
If you don’t think you’ll need an annual income of £80,000 – lets say £40,000 will be enough for you – Half your monthly contributions to around £220 and end up with a pension pot of £500,000.
We’re not talking about mega returns. We’re not talking about saving 50 percent to 60 percent of your income. We’re not talking about doing anything extreme.
See next page for dealing with inflation……
Imagine that you increase your savings rate by another 3 percent. Now you’re saving £506 per month, instead of £445. This move shaves two years off of your retirement timeline. If you start investing at age 25, you’ll retire a millionaire at age 58 instead of 60.
Yes just £61 a month — the price of a good night out — will help you achieve your goals two years earlier. That’s all thanks to the power of compound growth over time.
Of course, thanks to inflation, £1 million in 35 years won’t be worth the same as £1 million today. However, if inflation continues to run 2 percent annually over the next 35 years (as predicted by the OECD) and your investments gain at 8 percent annually, you’re still outpacing inflation by more than quadruple its rate.
Do you want to protect yourself against inflation even more? Here at MyMoneyExpert we strongly recommend using the investment strategy we just reviewed alongside paying off your mortgage. Paying it off gives you the following benefits:
- You’ll retire with your own home.
- No more monthly mortgage payments during your retirement.
- The value of your home will continue to rise with inflation, assuming it’s not in a severely declining market.
Also, in the example provided we’ve assumed your salary remains £26,700 from age 25 to 60. It’s declining with inflation, yet the numbers still work out to £1 million. We’re also assuming you’ll continue contributing the same £445 per month to your investments, an amount that declines with inflation over time.
In reality it’s highly likely you’ll grow your salary and retirement contributions at the rate of inflation. This would put you much further ahead than if you were to continue contributing the same raw £445 over 35 years. It should shave off another few years before you achieve the magic £1m mark.
We hope this article has been useful as a simple guide to achieving a very comfortable retirement, you’ll be able to retire a millionaire just by starting early, being disciplined, patient, and riding out the waves of the UK stock markets.
With investment, your capital is at risk. Pension rules apply and tax rules may change in future.