The problem with retirement saving is no one knows how much money they will need because they have no way of knowing how long they will live.
Other factors come into play as well, such as lifestyle and health.
Financial planners try to guess the best savings target from cash flow modelling.
The technology looks at someone’s current finances and savings goals and then tries to predict how much money is needed in the future.
The aim is to answer questions like how much someone needs to save, if they are saving enough and will any money remain for an inheritance.
The starting point is benchmarking – that’s looking at what someone earns and spends now. Benchmarking can also factor in life events, like marriage, divorce, changing jobs and having children.
The software then takes in the details and crunches the numbers to come up with a cash forecast for the future.
Accuracy is a problem. The model is only as good as the information fed in and unforeseen events can and do happen.
Advice firm Tilney bases financial recommendations on cash flow modelling.
The firm estimates that a well-off household spends £1 million in retirement, although the savings targets for 94% of the population are more modest.
How much will you spend in retirement?
The top 25% of wealthy households get through £683,000 and even an average retired household is expected to spend £420,000.
For a wealthy household, that’s £27,320 a year over a 25-year retirement. Take away the annual state pension of £16,600 for a couple, savings will then need to fund £10,720 a year, which is a pot of £268,000.
Tax relief, interest and dividends on savings over a lifetime will certainly add value to a pension, but the main impact is how much someone saves and when they start.
Cash flow modelling can help set the savings target and review progress along the way.
Dominic Lacey, a Tilney financial planner said: “When I first meet clients, most are anxious about the unknown and what the future might hold financially. They aren’t certain whether they will achieve everything they want to. Cash flow modelling brings their finances to life – we can see in real time how these will pan out in the future and play with different scenarios.”