As learning children, we were often told by our parents, extended family, and teachers that we must strive for maximum performance in our academic pursuits.
Scholarly success, we were told, would translate to excellent educational options in the future, and beyond this would yield results in the jobs market.
It’s a simple and truthful relationship that seems to hold for the most part. In the UK, the Government published a report about the impact of undergraduate degrees on early-career earnings which essentially agreed with this statement.
It concluded that “We show that at age 29, men who attend HE [Higher Education, i.e. University] earn around 25% more than those who do not, and women who attend HE earn 50% more”.
The impact of hard work on these financial outcomes is stark. It serves as a reminder that early attainment in school will still benefit our incomes as young adults.
However, life moves onward and 35 years later we may have now settled into an established career path and have risen several ranks in their organization. To get here, we will have taken on far more responsibility at work, possibly holding a senior management role.
We are probably caught in the trap of being ‘always available, which existed in office cultures prior to the Pandemic but has also been accelerated by it. While our income will now be very comfortable, the stress and anxiety caused by work are beginning to erode the joy of life.
In such a scenario it’s easy to empathize with someone wondering how much money is needed to quit your job? I’m sure you have thought about this after a bad work day or during an exceptionally boring or repetitive piece of work.
In this article, we’ll use different financial techniques to calculate the lump sum you would need to hold in assets to be able to retire. Retirement planning is a game of probability – because we don’t know our future needs, and we don’t know how with certainty how the value of our investments will change over time. That’s why we’ll also involve the factor of ‘confidence’ into the mix, as a more confident number will always be higher.
How to calculate the amount of wealth you need to quit your job
Simplistically, you could begin by calculating the value of capital that would be needed to produce the current level of income you enjoy today.
If you save via a tax-free stockbroker account such as a Stocks & Shares ISA, your retirement income will be tax-free so you shouldn’t need to consider taxes in this equation for now, though this is an assumption worth revisiting later.
Take the value of your take-home pay and divide by the % below that corresponds to your investment risk profile:
3% – I am a risk-averse saver and would not want to invest in the stock market
4% – I am a cautious investor but am prepared to take some risks in exchange for a higher return
5% – I am an adventurous investor and can stomach losses or the risk of running out of money in the hope of generating the maximum income overall
For example, if your take-home pay is £36,000 and you are a cautious investor, then the capital value you would need to generate £36,000 of income from your investments is £36,000 / 4% = £900,000.
Yikes, that’s quite a large number, I hear you say. Surely most adults on a reasonable salary do not save up close to a £million before retiring?
Well unfortunately the numbers don’t lie. At a 4% rate of return, it would take a pot of £900k to generate a £36k per annum income.
Changes to assumptions that could reduce the money you need to retire:
However, don’t despair as there are other helpful elements to consider:
- The UK State Pension is worth up to £185.15 per week, which is £9,600 per year. You won’t need to fund this part with your own investments if you are past the official retirement age.
- This calculation assumes that you only ‘live off the interest’ of your savings for life, whereas in reality, you may start withdrawing the principal amount and using this.
- Your needs may change, and following retirement, you may find that it’s much cheaper to enjoy the same quality of life. Free from the constraints of work, you are flexible with your time and can take advantage of the many money-saving offers available to ‘early birds’ or those who can enjoy activities during the working week. You may even realize you don’t need a second car in the household now that you’re not commuting.
- You should be aiming to have no outstanding mortgage on your property at retirement. This means you won’t need the salary you currently use to pay that down.
Another option to consider is whether you want to ‘ramp down’ your working life for 5 – 10 years in advance of retirement. This could include reducing your hours from a 5-day week to a 3-day week or swapping your stressful professional career for a less pressurized position that still utilizes your skills.
By going halfway to retirement, you’ll realize many of the benefits of having extra free time, but crucially your employment income will still cover all, if not most, of your overheads. By pushing your real retirement date backward, your pot will only need to cover a much shorter retirement period.
Due to relatively low rates of return, retirement isn’t easy. To receive an income of £100 per year, you would need to save £2,500 in an investment that could produce an income of 4%. This means that when incomes are large, the retirement targets become staggering and that can put many savers off from even starting their retirement plan.
The reason why some do succeed in building up the immense pots needed to quit their jobs and live a life free from work is that they do so gradually over extremely long time horizons. Much like it feels like a mortgage will never be paid off – it will be zero by the end of the 25-year loan term.
A retirement savings account should be viewed with the same level of patience.