The definition of retirement is changing and we’re all screwed.

According to the government:

“Default retirement age (formerly 65) has been phased out – most people can now work for as long as they want to.”

Well. Thanks a lot…. that’s one way of putting it! Even more worryingly, if we delve into this government pension reform consultation paper we find the motivations behind upcoming pension reform:

“It should encourage people to save enough during their working lives to meet their aspirations for a sufficient standard of living in retirement.

It should enable individuals to take personal responsibility for ensuring they have adequate savings for retirement.”

I don’t know how you read that, but to me it sounds like they are saying that it is each individual’s personal responsibility to provide for their retirement – and if they don’t then tough, no retirement for you.

It’s not just the government that’s changing, also gone are the cushy company pensions as a reward for a career working at one place. Our working culture has changed, but our saving habits haven’t kept up, in fact we are saving less than ever before – one study found that 1/3rd of brits aren’t saving any money at all.

Is it really as bad as all that? Well, we don’t know what is ahead of us, in 40 years there could be a great welfare system or awesome company pensions that will pamper us for the remainder of our lives. Or we could have nothing and be totally reliant on what we have saved.

Whatever your walk of life, self-employed or employee, saving is important.

Amongst all this doom and gloom, there are some positives. Salaries are high and investing is easy (don’t believe me? Check out historic average salaries in the UK, adjusted for inflation the average salary is now double what it was in 1975). I’ve spoken before about becoming financially independent, but now let’s do a proper study on what it takes for a young graduate living in London to save for retirement. It’s easier than you might think, our graduate simply needs to:

  1. Start early in life.
  2. Invest what they save.
  3. Avoid lifestyle inflation.

Meet Gary, he is fresh faced and buzzing with excitement to start his new job in the daunting city of London. He is 21 and has graduated with a 2:1 degree in Psychology from Southhampton University. He has a job working at a medium sized company on the graduate scheme, starting at £25,500 – quite a lot lower than the average London graduate salary of £29k.

He has no savings and the maximum student loan. The exact size of the loan doesn’t matter because if all goes to plan it is unlikely he will have to pay all of it off.

Luckily for Gary he is very into both financial independence and frugal living so he is determined to save and retire as soon as possible.

From the £25,500 he pays £2,980 in income tax, £2,093 in national insurance and £773 in student loan repayments. Leaving him with £19,654 a year, or £1,638 a month. (worked out from this calculator)

His expenses are:

  • He rents a roomshare in Finsbury for £750 a month including all bills.
  • He has a bicycle and cycles as much as possible including to and from work. Occasionally he has to get public transport which comes to £20 a month.
  • He has a mobile phone contract of £25 a month.
  • He has a Netflix account costing £5 a month.
  • A haircut every three weeks working out at £15 a month.
  • He cooks all his food at home. He’s into good quality organic food so spends a large £260 a month.
  • Once a week he eats out or goes to the pub with his friends spending on average £25 a week, or £107.5 a month.
  • The rest of the week he either hosts friends, goes to houseparties, chills on his own or does all the great free stuff around London.
  • He goes on holiday once a year and spends £1,000. Or £83 a month.
  • He doesn’t buy many clothes or gadgets but has a £150 a month budget to cover wear and tear, new clothes, and miscellaneous expenses.

So in total Gary spends £1,415.5 a month. He puts the remaining £222.5 into a stocks and shares ISA and invest in equities. Which earns a historical real return of 5% (5% plus inflation) a year.

Over the years Gary works hard, enjoys life and, unlike his friends, doesn’t raise his spending as his salary increases. He loves his life and doesn’t see the need the spend any more money, his life was good when he was 21 and he understands that due to hedonistic adaptation, spending more won’t make him any happier. Every time his pay increase he just keeps putting the extra into his investments.

Gary’s career was pretty uneventful. Plenty of younger people shot past him on the career ladder, but neither was he unfairly held back. Over a 14 year period, Gary’s salary increased in real terms by on average 8% a year and by the end of his 35th year he had made it to the position of vice president, earning £60,000 and taking home, after tax and student loan, £38,248.

At some point, Gary reaches a stage where he is maxing out his ISA allowance of £15,000 a year. So he puts the extra in a self-invested personal pension (or SIPP) – giving him an immediate return of 20% in the form of a tax refund. Most of his money is still in the ISAs which means when he comes to withdraw he can juggle his withdrawals and benefit from a completely tax-free income.

At this point, Gary’s career stalls and for the rest of his working career his salary only goes up by inflation. Gary has so far had a pretty average middle-class life.

But the beauty is that everything he has saved starts to earn him money, and it doesn’t take long before his savings are earning more money than he is! This process is known as compound interest.

retire by 40

Here is the spreadsheet used to work out Gary’s lifetime finances.

Check out where the red and green lines cross. This is the point of Gary’s financial independence, the point when his savings are earning him enough money to cover all of his expenses. The point when he can retire.

And how much does Gary have in savings by the time he reaches 65? £1.9 million! Earning him a massive £91k a year tax-free.

Ok, I am sure that this is an oversimplified example and you have probably found a few things I have not accounted for. In fact, the only thing we can be sure of is that Gary’s life won’t pan out exactly like that.

He may get married (which would reduce his expenses as he’d be sharing some of them, leading to an earlier retirement). He may have kids (which will up his expenses and lead to a later retirement). He may inherit some money, he may have a few years of earning a smaller return. He might get a performance bonus at work, or he might be passed over again and again for promotion. He may buy a house (reducing his monthly rent expenses) or he may upgrade and rent somewhere more expensive on his own.

Gary might not retire by 40. But he will definitely be able to retire at some point and chances are it will be long before 65.

I am not a financial advisor and cannot give financial advice. This article I hope will convince you of the importance and power of saving. If you want to act you should speak to a financial advisor for a saving schedule tailored to your personal circumstances. Check out this article on Money Saving Expert on how to find a good financial advisor.