Article Category: Finance
Last updated: 28 May 2009
Proper retirement planning is essential if you want to sustain a comfortable lifestyle beyond retirement age. When you’re just starting out in your chosen career, it’s all too easy to put off thinking about pensions, however the golden rule in retirement planning is: act now.
Even if you can only afford to salt away a small amount of money each month at the moment, the sooner you start, the more you’ll have to play with in your golden retirement years. Beware: waiting just a few years to start saving for your retirement could mean the difference between tanning on yearly Caribbean cruises and struggling to pay your heating bill – and it’s all to do with compound interest.
The power of compound interest rests solely in the length of time your retirement money stays in the pension account. As you invest in your pension, the money earned in interest is paid into your account so that future interest growth is applied to interest from previous years as well as the capital you’ve paid in. Over the short term compound interest has a negligible effect, however over a period of 30-40 years compound interest can enable retirement investments to grow significantly: for example, $1000 invested at 5% interest and left for 40 years will be worth over $7000.
The oft-quoted rule of thumb for the amount to save for your retirement is to halve your current age and then save that percentage of your gross income, e.g. a 24-year-old should save 12% of their gross income into a pension. This is far better than no pension at all, however, this ‘one size fits all’ approach fails to take into account many additional factors: what lifestyle you want to have in your retirement
years, how active you’ll be, where you want to live and if you’ll still have a mortgage or dependents.
A better way to estimate how much you need to save each month into a pension is to work out your target retirement income, based on your desired lifestyle. Write down all the outgoings you think you’ll have in your retirement, according to today’s prices. Try to add in as much detail as you can, including all the little luxuries that you take for granted currently. Will you want to join a health or golf club? How much will your heating bill be? Do you want to holiday regularly? How much will you spend on going out – less or more? Total this and add in something for tax to get your target yearly retirement income.
Once you have your retirement target, you can use our compound interest calculators to determine how much you need to invest in order to achieve that income. Our first calculator works out interest on a lump savings amount. Use this if you already have an amount in a pension and you want to check how close you are to your target retirement income. The second calculator allows you to include regular monthly savings deposits – use this to see how much to save in your pension fund to make up the difference on your savings.
You can also use our retirement planner tool to work out how much you should be saving each month to achieve your retirement goal.
Retirement planning is perhaps the biggest exercise in delayed gratification that most of us will ever perform, yet start today and your retired self will be thanking you as they sun themselves on that Caribbean cruise.
Written by James Redden
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Category: Personal Finance