The Cost of Life
In Aug 2019, I wrote a blog called How Much Is Enough? The idea was pretty simple.
Rather than starting with “What day rate can I charge?”, start with a different question:
What does the life I want to live actually cost?
Then work backwards.
If the good life requires a certain income, and you realistically have a certain number of days each year that you can sell, you can begin to calculate what you need to charge.
But recently I realised there was another part of the equation I hadn’t really considered.
What about the life I want to live when I stop working?
For those of us who are self-employed, sole traders, consultants or directors of small limited companies, there probably isn’t a generous final-salary pension waiting for us. Nobody else is quietly preparing for our retirement. So perhaps we need to.
For the last few days I have been contemplating this more deeply. This is what I came up with!
Step 1: Work out what “enough” might look like in retirement
Don’t start with pensions. Start with life.
If you stopped working tomorrow, what would you actually need each month?
Mortgage or rent. Food. Holidays. Cars. Days out. Bills. Hobbies. Helping children or grandchildren. A bit of breathing space. You don’t need precision at this point. You just need a number.
Imagine, for example, that you decide that £30,000 a year in today’s money would allow you to live the kind of retirement you would be happy with. Now look at what income might already be coming.
The full new State Pension is currently £241.30 a week in the 2026/27 tax year, approximately £12,550 a year. Although what you receive depends upon your National Insurance record, so checking your own State Pension forecast is essential.
That gives our fictional person a gap of roughly:
£30,000 desired income (gross annual retirement income)
– £12,550 State Pension
= £17,450 a year
That is the bit their private pension, investments and other assets need to provide.
One useful rule of thumb is the “4% rule”.
The idea is that, rather than spending your pension pot down over a fixed number of years, you keep much of it invested and initially draw around 4% a year. Because 4% is one twenty-fifth of 100%, you can get a rough indication of the pension pot you might need by multiplying your required annual income by 25.
So, if our retirement income gap is £17,450:
£17,450 × 25 = approximately £436,000
Before panicking at that number, find out what you’ve already got. Check your State Pension forecast. Find your existing workplace and private pensions. Look at your ISA and other retirement savings. Then establish your actual starting point.
A £436,000 pot withdrawing 4% would provide around £17,450 in the first year.
This isn’t a guarantee, investment performance, inflation, tax, retirement length and how flexible you can be with withdrawals all matter. But it provides a useful starting point for doing the maths. So please don’t mistake £436,000 for some magical number that guarantees retirement happiness. But it gives us something incredibly useful – a target to work with.
Step 2: Remember the gap before the State Pension
This was one of the bigger realisations in my own planning. My ambition is to have the choice to retire at around 60. But retirement age and State Pension age aren’t necessarily the same thing. If, for example, your State Pension forecast says you will receive it at 67 and you want to finish working at 60, you have another question to ask!
How will I fund those seven years?
That might mean drawing more heavily from a private pension, ISA or other savings during that period and reducing withdrawals once the State Pension begins.
Don’t just calculate retirement. Calculate the bridge to retirement too. I’m trying to fill mine with increasing contributions to my private pension and sticking what I can into various ISAs! But this aspiration is dependent on the next step!
Step 3: Make your business behave like a business
This is where my thinking about business banking changed. For years most of my income would just sit in one account. It was easy to look at the balance in the company account and think:
“That’s how much money I’ve got.”
But that wasn’t the case, some belongs to HMRC, some was needed to pay the bills, some is needed to protect the business if work disappears and some might actually be mine (profit).
So I have started thinking about company money a bit more strategically (well like an adult) and have created four separate pots (Startling Bank is great for this).
To give you an example, it might look something like:
Pot 1: Operating approx. £xxxxx
Basically, the money required to run the business and meet its regular commitments e.g. salary, pension, accountant fees, insurance, subscriptions, web hosting training/CPD and new kit and travel. In practice, whenever money comes into the business I move 15% straight into the tax pot. I keep the operating account topped up to cover normal commitments, maintain my reserve at its agreed level and anything genuinely surplus can then move into the surplus/future pot.
Pot 2: Tax approx. £xxxxx
The money that isn’t really mine and needs to be protected for Corporation Tax and other liabilities. I use 15% of every payment received as a cash-management rule, not as a Corporation Tax calculation. It works for my business because I’ve looked at prevous accounts and its simple for my brain. This is likely to be an overestimate, so I’ll probably have some additional profit from this pot at the end of the year. Your tax position may be completely different (as low as 6% of your profit may be enough).
Pot 3: Reserve approx. £xxxxx
This represents 3 three months’ salary (and associated business costs), which gives me the breathing space needed should work slowdown. This should remain stable or grow when times are good to improve the buffer.
Pot 4: Surplus/Future approx. £xxxxx
This is the money left once I’ve provided for operating costs, tax and my agreed reserve. Subject to what the company has actually earned and what my accountant tells me is available, this gives me choices… It’s this money that I can play with e.g. increase company pension contribution / retain it in the business / take an appropriate dividend / use personal dividend income to fund an ISA (to gap fill the years between retirement at 60 years of age and state pension age of 67 years).
Your numbers will be completely different. That’s the point. Do your maths.
Step 4: Add “future me” to the payroll
Once I had separated the business money, another question became much easier:
What can the business afford to invest in my retirement?
In my own planning I have used this process to:
- Increase my monthly pension contributions
- Plan for additional annual one-off pension contributions in good years
- Increase dividends to give me the ability to contribute to a Stocks & Shares ISA
Another £100 a month into an ISA is £1,200 a year, or £12,000 over ten years, before any growth.
Suddenly retirement planning feels less abstract, the underlying question is:
How much of what I earn today am I giving to the person I will become?
Step 5: Do your own equation
So perhaps the companion equation to my original How Much Is Enough? looks something like this:
- What annual income would give me a good retirement?
- What State Pension and other guaranteed income might I receive?
- What’s the annual gap?
- Roughly how large might my private retirement pot need to be?
- If I want to retire before State Pension age, how will I fund the bridge?
- What do I already have?
- How much am I currently adding each year?
- Is that enough to give me a reasonable chance of getting there?
- What does my business need to generate to make those contributions possible?
Which takes us right back to the first blog. Because perhaps your day rate shouldn’t just pay for today’s good life. It needs to make a contribution towards tomorrow’s good life too.
In the original How Much Is Enough? blog we calculated that you may have as little as 132 billable days, so now we need to ask, how much of every billable day needs to fund future me?
When you work for yourself, retirement planning isn’t something that happens somewhere else in the organisation. You are the employee. You are the employer. You are the finance department. You are the pension committee. And, unfortunately, you are also the person who gets to 60 and discovers whether any of this worked. So don’t leave that person whatever happens to be left.
Put them in the budget now.
Fancy a chat… contact me here or just e mail kurt@bemorelnd.co.uk