Will you be able to live comfortably on the State Pension when you retire? At current levels, the it provides a payment of £164.35 per week, or £8,546.20 each year. For many of us, this won’t be enough.
Although I expect my living costs to fall by the time I reach retirement age, I hope that my stock market investments will allow me to buy an annuity to supplement my State Pension. In fact, my aim at the moment is to buy an annuity income that will not just add to, but will match, my State Pension.
In other words, I want to double the amount I get each week. Here’s how I plan to do this.
How much will I need to retire?
I don’t know when I’m going to retire, but I’m basing my plans on the idea that I might be able to retire in 20 years’ time.
The current State Pension is £8,546 per year. Under the government’s triple-lock guarantee this payment will rise by a minimum of 2.5% each year. Based on this rate of growth, in 20 years the State Pension will be £14,178 each year.
Obviously I don’t know what annuity rates will be like in 20 years’ time, so I’m going to base my assumption on what’s available at the moment. At the time of writing, a 65-year old buying a single life level annuity can expect a return of about 5.4% per year, according to Hargreaves Lansdown.
Using this rate, my sums indicate that in 20 years, a lump sum of £262,556 will allow me to buy an income that matches the State Pension.
How much should I save each month?
Over a period of 20 years, I strongly believe that the stock market is likely to be the best way to build wealth. As I’m still working, my savings will be drip-fed monthly into an ISA.
Figures put together by Barclays indicate that the long-term average return on UK stocks is about 8% per year. In my view, the most reliable way to harness this long-term earning power is to drip-feed money into a FTSE 100 tracker fund within a Stocks and Shares ISA. This will ensure that you’ll never have to pay tax on the income or gains from your investment.
My sums indicate that with an annual return of 8%, I’d need to save £446 per month to have a £262,556 fund in 20 years’ time.
Should I buy shares instead?
Of course, financial planning is only an approximation. The exact amount I’ll have in 20 years will be different. As an enthusiastic investor, I hope to be able to beat the market over this period by buying stocks directly, rather than investing in the whole market through a tracker fund.
The risk with stock picking is that it’s not easy to beat the market consistently over two decades. In my view, a tracker fund will work well for most people. But if you’re interested in stock picking, I’d start by building a portfolio of dividend-paying big-cap stocks. If you can hold on through market crashes and buy more when your stocks are cheap, I believe you could beat the market and perhaps even retire early.