Drew Nutsford: pensions maths test will help you find the answers

We at Waverton wish them all every success.

Sadly, far too many investors will open their pension fund annual statements this year, and – like some of those maths students – will just simply hope for the best.

How else do we explain that the average value of a UK pension pot today for a 55-64 year old is only £107,300? That would only buy a healthy male aged 65, living in the Central Belt, at best, an annual income of circa £7,800 (based on a cash purchase price of £107,300). After a lifetime of work, that’s a huge and financially disastrous fail, and it gets worse, as one in four retirees today have no retirement fund at all.

For those readers who are looking for a much more comfortable retirement lifestyle, it is vital to sit down today and pass a pensions maths test. It won’t take long, as it is only four questions. To make it easier for you, there is only one question where we haven’t provided the answer.

I invite you to try it now...

Question 1 What size of retirement fund will a couple need to provide a “comfortable” annual retirement income of £59,000 a year? (Considered “comfortable”, according to the Pensions and Lifetime Savings Association.)

Answer £929,000, and this assumes you also qualify for the full state pension. That is almost nine times the current average pension fund value of today’s 65-year-old retiree. But a supplementary question must surely be: would a joint annual income of £59,000 really be “comfortable” enough?

Question 2 What annual percentage rate should you use to forecast your pension fund growth?

Answer For many, 4 per cent is a good guideline, although if your funds are invested well, you may see your pension fund increase in value over time. The 4 per cent rate is often used as a general rule of thumb to calculate the annual income that you could take from your pension fund at retirement. That starting rate, plus an annual inflation increase, will help to ensure your retirement fund doesn’t run out before you do.

Question 3 What is the maximum I can invest into my pension each year?

Answer Depending on your circumstances, it could be a healthy £60,000 a year.

Question 4 How much will my pension need to be to support my desired lifestyle in later years?

Answer “X”. This is the one unknown in this exam, and it is the key question for you to answer today. Get it right and plan accordingly and your retirement will be secure.

Only you know what quality of lifestyle you want in retirement. How many holidays, hobbies, new cars? Financial help to your family? Home improvements?

It is not an easy answer to accurately calculate. This is where an experienced wealth planner can really benefit you, especially an adviser who can provide their clients with access to sophisticated cash flow modelling.

Some advisers use cash flow modelling tools to help advise clients to forecast their future finances and how much money will be needed in retirement to maintain their chosen lifestyle.

This method can also help identify what level of annual pension contributions are realistically needed to achieve that goal.

In the years ahead, using this approach to help maintain your income and expenditure, along with your other investments and assets, will allow you to make appropriate and timely corrections, as required, to keep your retirement financial goals on track.

Working out what your retirement goals are, and enlisting the services of a wealth planner, could mean you will no longer be “hoping for the best”, allowing you to create a clear plan for retirement.

Cash flow modelling can help to ensure that you pass your pensions maths test with flying colours. Try it today.

- Drew Nutsford is a chartered financial planner and a Fellow of the Personal Financial Society.