In 2020, the state pension age for British men and women will rise to 66. Between 2026 and 2028, it’s going to increase to 67.
We’re living longer, so we have to work longer. I understand that. But what if it was possible to retire before reaching state pension age?
Retiring in 2020
I admit that not everyone is going to be in a position to retire in five years’ time. But you may be surprised at how close you can get with a few simple changes to your financial lifestyle.
The first step is to work out how much you will need to live on. Do you need a pension income for the rest of your life, or a fund to support you for a fixed period until you can claim an occupational or state pension?
In either case, you may find you need less to live on than you expect once you’ve retired, especially if you can pay off your mortgage before you retire.
For example, a £750 monthly mortgage payment requires around £11,500 of pre-tax earnings, for a standard rate taxpayer.
Another saving is that you won’t need to save as much! Saving is vital when you’re working, but once you retire, you’ll save much less. Indeed, as long as you have a rainy day fund, you may not need to save anything from your retirement income.
Whatever your situation, there are three things I believe you need to focus on.
1. Debt is the killer
I’ve already discussed the benefits of paying off your mortgage before retiring. The same advantages apply to all forms of debt.
If you’re aiming to retire early and want to minimise your pension requirements, you need to clear as much debt as possible before you retire. Interest costs on debt will eat into your pension income and make it much harder to live comfortably.
2. What to do today
The simplest way to bring forwards your retirement date is to spend less and save more today!
Money works harder for you when it’s saved early.
For example, if you invested £10,000 today at an interest rate of 5% and reinvested the interest every year for ten years, you’d end up with £16,288. This powerful effect is known as compounding.
3. You’ll need the stock market
According to Barclays, shares have delivered an average annual return after inflation of 5.5% over the last 50 years.
In contrast, the average inflation-adjusted return on UK government bonds (known as gilts) over the same period has been just 2.5%.
For cash savings, it’s even lower.
Although shares can be more volatile than bonds, they do tend to deliver better returns over the long term.
So how much will you need?
The FTSE 100 currently offers a dividend yield of 3.8%. If you invested your retirement savings in a cheap FTSE 100 tracker fund and aimed to live off the dividends, then my calculations suggest you’d need about £650,000 to generate an annual income of £24,000.
Of course, this is only a rough estimate. Although dividends tend to rise with inflation, they sometimes fall, too.
