In 2020, the state pension age for British men and women will rise to 66. Between 2026 and 2028, its going to increase to 67.
Were 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 youve 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 wont need to save as much! Saving is vital when youre working, but once you retire, youll 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
Ive already discussed the benefits of paying off your mortgage before retiring. The same advantages apply to all forms of debt.
If youre 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 its 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, youd end up with 16,288. This powerful effect is known as compounding.
3. Youll 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, its 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 youd 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.
I’d always suggest taking professional advice before making such an important decision.
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