What do you REALLY need to save for retirement? We reveal how to work out the income you require and the pension pot it will take

It's the million-pound question: how much is enough when it comes to saving for retirement?

According to official figures, four in ten of us are underestimating what we need to set aside.

Half of the 12 million workers 'under-saving' earn at least £34,500 a year, according to a Government study of its flagship workplace pension scheme.

That means 6 million middle-class workers face a drop in their standard of living when they retire, unless they act now.

Most people save into 'defined contribution' plans that are linked to the stock market. With these deals, working out just how much you need to set aside to ensure a comfortable retirement is tricky.

So how much do you need in old age? And how can you make sure you're saving enough? Money Mail has the answers...

Calculators at the ready

Your first task is to work out what income you'll need when you stop work.

Experts disagree on what this target should be. Some say you should aim for two-thirds of your final salary. For someone on the average UK wage of £27,000, that would mean an annual income of £18,000 in retirement.

The Department for Work and Pensions analysis, published this week, says someone on £13,000 or less should aim to have 80 per cent of their salary in old age, or £10,400 a year. For someone on more than £55,000 it recommends 50 per cent, or £27,500 a year.

Other experts suggest setting aside a lump sum worth ten times your final salary. So someone earning £27,000 would need £270,000 to see them through old age.

In truth, everyone is different. To work out the right number for you, sit down with a pen and paper and roughly calculate your likely retirement outgoings.

Start with essential spending such as utility bills, running the car, the food shop and repairs.

The Office for National Statistics says the average annual food spend is £2,808 while gas and power bills cost £1,253. Remember, these numbers will rise every year with inflation.

Next, consider the costs of the lifestyle you want. Include holidays, meals out and hobbies such as golf or dancing classes.

Take into account practical considerations such as whether your spouse will be relying on your pension, and whether you might downsize your property or move into retirement accommodation which charges fees.

Don't underestimate your life expectancy. Many savers only expect their pension pot to need to last them a few years but a 65-year-old can typically expect to live two more decades.

Peter Chadborn, director at advice firm Plan Money, says: 'We are living longer in retirement and each generation seems to want a better retirement lifestyle than the one before. You may have 40 years of earning to save enough for 25 years of not earning.'

Remember the state pension will lighten your load (get a forecast at gov.uk/check-state-pension or call the Future Pension Centre on 0800 731 7898.

The full £159.55 a week flat-rate payout works out at £8,296 a year. So if you're aiming to have a retirement income of £18,000 a year, you'll need to fund about £10,000 yourself.

You should multiply this amount by 25 years to work out the absolute minimum you'll need — £250,000 in this case.

This figure presumes you'll run down the pot gradually so nothing is left. In reality, you're likely to continue to get a return on your savings during retirement if you've invested them wisely.

You won't want the pot to run dry in case you live beyond 25 years, or so you can leave something for a spouse. So think of these figures as a starting point.

How to cover the basics

The International Longevity Centre think-tank estimates that workers typically needs to save 18 per cent of their salary to obtain these target retirement incomes.

With bills, mortgages and supporting children through university, that's far too much for most people to give up.

One solution is to start saving as early as possible. This gives your money longer to grow — and means it gets an extra boost from compound interest.

Experts say it's a mistake to wait until you don't have a mortgage and the children have flown the nest.

Peter Chadborn says: 'A little from a young age is a good discipline — waiting until you're mortgage-free might mean you can save more but you won't have as long to do it.'

Jamie Clark, business development manager at Royal London, adds: 'Start small and increase your savings every time your salary rises. This way your pension should track in line with your lifestyle.'

Say you decide £15,000 a year will see you through in old age. After taking into account the £8,296 state pension, you need to fund £6,700 a year yourself.

Multiply that by 25 years and you will need £167,500.

If you start saving at age 20 and the funds in your pension pot grow at 5 per cent a year, you'd need to put £82.50 a month into your pension to build up £167,000 by age 65. If you waited until age 40, you'd have to save a much bigger £280 a month to amass the same amount.

Under the Government's flagship retirement scheme introduced in 2012, the vast majority of company staff are now automatically enrolled into pensions by default. But not enough is going into their pots.

The finding that 12 million people are under-saving comes from the DWP's analysis of its 'auto-enrolment' programme.

Currently, only a minimum of 2 per cent of your annual salary must go into your pension pot under the DWP's rules.

Half of this must come from your employer (they pay this on top of your normal salary). Basic-rate taxpayers then have a minimum of 0.8 percentage points and higher-rate payers 0.6 percentage points deducted from their salary and put into the pension. T

he remaining 0.2 or 0.4 percentage points comes from the Government in the form of tax relief.

These numbers will be slightly different in Scotland after the SNP hiked its income tax rates last week.

Firms are only obliged to ensure 2 per cent of earnings between £5,876 and £45,000 go into your pension. If you saved 2 per cent of the full average £27,000 salary, a total of £45 (including tax relief and your employer's contribution) goes into the pot each month. At that rate, if you started saving at age 20 you would have just £24,300 by age 65.

But the benefits of a workplace pension mean it wouldn't cost the earth to increase your savings to the magic £82.50-a-month mark.

At least £22.50 of this would come from your employer (the 1 per cent payment your boss must make), with the Government providing £12 in tax relief. That leaves you sacrificing £48 a month from your salary.

Again, these figures will be a few pounds different in Scotland under its tax changes.

If you're starting at age 40 and need to put aside £280 a month, tax relief would provide £51.50 and your employer would pay £22.50.

That leaves you needing to contribute £206 from your salary. The minimum percentage for auto-enrolment savings will rise to a total of 5 per cent in April 2018 and again a year later to 8 per cent.

Saving that percentage from the full £27,000 average income would increase your contribution to £180 a month, or £2,160 a year, meaning you'd comfortably meet your target for a £15,000 annual income.

To get the £6,700 not covered by the state pension from an annuity — your main alternative option, which provides a guaranteed income for as long as you live — you'd need to set aside £207,000, according to figures from investment company Fidelity. This is based on a policy for a single pensioner with payouts rising by RPI inflation each year.

Contact the pensions department or whoever deals with HR at your employer to find out how much is going into your plan.

Good employers often pay in more than the minimum — for example, matching your contribution so if you pay in 5 per cent the company adds another 5 per cent.

Save extra for special treats

Many savers will want more than £15,000 a year in retirement.

To get to £25,000, your savings will need to generate £16,700 in income, after the state pension is taken into account. That means building up £417,500 if you want your pot to last 25 years.

If you save from age 20 to 65 and your investments grow at 5 per cent a year, you will need to set aside £205 a month.