Here's exactly how much inheritance YOU need to retire early, the tricks to use so you NEVER run out of money and how to avoid tax headaches

An inheritance is likely to be the biggest windfall ever to drop into your bank account – one that could change your life.

But most of us don’t plan too carefully for what we’d do with it. That’s because it’s never guaranteed – someone from whom you expect to receive an inheritance could spend it themselves, need the money for care home fees or leave it to someone else.

And, of course, it can be hard to think about, as an inheritance almost always follows the loss of a loved one when you’re in the depths of grief.

For most, inheritances do not typically come early in life, when the money could help you get on the property ladder or pay off student loans.

Instead, as people live longer than in previous generations, most now inherit on the cusp of retirement, when it can make a big difference to whether you keep working or can afford to stop.

If you were born between 1980 and 1996, the typical age at which you can expect to receive an inheritance is 62, according to the Resolution Foundation think-tank.

One in five people now in their 60s who were recent beneficiaries of an inheritance received between £100,000 and £250,000, according to its analysis.

It’s perhaps inevitable that receiving such a large sum at this age would prompt questions about cutting down hours or retiring early.

The size of inheritances is also growing, increasing the likelihood of receiving a life-changing sum.

If you were born in the 1980s, the average inheritance would amount to about 16 per cent of your lifetime income, while for those born in the 1960s it would make up 9 per cent, a separate study by the Institute For Fiscal Studies found.

So would receiving an inheritance allow you to bring forward your retirement age? How do you work out how much you need to retire early and what can you do to ensure that the money lasts?

Wealth & Personal Finance asked financial advisers and experts to share their tips...

Many of us dream of retiring early to have more time to do the things we enjoy.

But the earlier you leave work the longer you will have to make your money last – and the greater the risk of running out towards the end of your life.

It can be tricky to figure out exactly how much you will need to do this. The key is to work out how much you would need for the lifestyle you aspire to and then calculate if, between your pensions and inherited plus other wealth, you would have enough to last you.

While still in your working years, it can be hard to imagine what your costs will be in retirement.

Industry body Pensions UK has come up with simple rules of thumb, which you can use as a starting point.

For example, it says that a single person needs an income of £32,700 a year for a decent retirement. This so-called moderate lifestyle covers the essentials, plus some left over to splash out on food and entertainment, trips abroad and running a car. Couples need a joint income of £45,400 for the same lifestyle.

The very minimum a single person needs to get by is £13,900 a year and £22,500 for a couple, while they need an income of £45,400 and £62,700, respectively for an affluent lifestyle.

These headline targets don’t include some very important items, which should be factored in, such as income tax, housing costs if you are still paying a mortgage or rent and care costs in later life.

As a general rule, if you wanted an income of £32,700 – rising with inflation every year – you would need a lump sum of around £473,000 by the age of 66, according to pension firm Standard Life.

The calculations assume you are a basic-rate taxpayer who needs a pre-tax income of £37,732 to reach £32,700 after tax, and that you would receive the full state pension, currently worth £12,548 a year.

If you already have this amount in your pension and other savings when you receive an inheritance, you are likely to be well placed to use your windfall to knock some years off your retirement date.

However, you need to remember that your years of early retirement are likely to be significantly more expensive than those after state pension age and beyond.

If you wanted to retire with the same lifestyle at the age of 60, you would need as much as £554,600 set aside, according to Standard Life. This is because not only would you need to cover an extra six years of expenditure, but you would have to use more of your savings in the first few years until you become eligible to claim your state pension.

If you are an energetic early retiree who has quit the world of work to enjoy travel, hobbies and socialising, those first years are likely to be even more expensive.

If you want a more accurate idea of how much you might need throughout all stages of retirement, financial advisers can help you to build what’s called a lifetime cashflow model.

This sets out your goals and likely expenditure and works out how much you will need and whether those plans are achievable based on what you have.

Factoring a potential inheritance into retirement plans is fraught with difficulty as it’s hard to know what you might receive – if anything – and at what age.

However, Adrian Murphy, chief executive of Murphy Wealth, suggests planning various scenarios, including one in which you receive an inheritance. He says: ‘We don’t base people’s financial plans on inheritance, as you don’t know when it will happen or how much it will be. But what we might do is a version of a plan where you can make reasonable assumptions and set out how different situations may look in the future.’

He adds: ‘You can take a notional number for inheritance and plug that in, which can either be used to provide a better retirement or bring the date forward.

‘Or, in cases where you can’t access your pension until a certain date, an inheritance could be used to bridge the gap between the point you want to retire and when you can start to take the benefits.’

More than three-quarters of workers are not on course to have enough saved for a moderate standard of living in retirement, trade body Pensions UK warns.

For those who have undersaved, an inheritance could be crucial not to retire early, but rather to retire at all with a decent income, says St James’s Place head of advice Claire Trott.

‘Rather than enabling people to retire earlier, it’s likely that using inheritance may increasingly become a financial necessity to help fill retirement savings gaps,’ she says.

You might also be surprised at how receiving an inheritance affects your attitude to work. You may have spent years dreaming about retiring early – but when given the opportunity to, realise that you are happy to continue.

Nick Nesbitt, partner and head of private client tax at Forvis Mazars, has noticed that sometimes people behave counter-intuitively and decide they want to carry on working just when they have inherited enough to stop.

He says: ‘While you would think it would serve as permission for people to retire, I quite often see the opposite – it changes their mental relationship with working because they no longer have to.

‘So, whether it’s an inheritance or some other form of windfall, you actually see many people continuing to work because they realise that when the pressure of having to earn goes, their relationship with working improves.’

Sam Patterson, head of proposition at Equilibrium Financial Planning, says that one client with a highly pressured and very successful career used an inheritance to turn her passion for restoring old furniture into a business – and now has more time for family, which her old job never allowed.

But when it comes to retirement, he says: ‘We see clients are using an inheritance to make gradual changes, such as reducing their working hours.

‘The most common challenge we hear is balancing the desire to enjoy today with the need to provide for tomorrow.’

His recommendation is to treat an inheritance as a foundation for the life you want to live, not something to use all at once.

Any inheritance you do receive may be subject to tax – so make sure to factor that in. You will need to consider the deceased person’s estate as a whole, not just the share you could receive, to calculate the total tax bill.

Everyone has a £325,000 allowance – called the nil-rate band – that can be passed on free of inheritance tax (IHT). Any wealth above this is subject to a 40 per cent rate.

There is also an additional tax-free allowance of £175,000 when a family home is left to ‘direct descendants’ such as children or grandchildren.

This creates a maximum total tax-free allowance of £500,000 for an individual or £1million for a married couple or civil partners.

There is no tax to pay on any property, assets or money inherited from a spouse or civil partner and their unused IHT allowance can be passed on when the surviving spouse dies.

If you do receive a windfall, make sure that you shield the cash from any further tax bills as best you can.

If you leave cash in a regular savings account, you could be taxed on the interest you earn. Most people have a personal savings allowance – this is the threshold below which you don’t need to pay tax on any interest you earn from your bank.

Basic rate taxpayers can earn £1,000 in savings interest before paying any tax, while higher-rate taxpayers have a £500 allowance. Additional rate taxpayers, earning more than £125,140 a year, get no personal savings allowance.

Consider saving and investing in cash and stocks and shares Isas where your money can grow free of tax on interest, profits or dividends. The annual Isa allowance for new contributions is £20,000.

You are likely to have to make inheritance and pension savings last for many decades, so how you spend them is crucial.

One of the easiest ways to guarantee you don’t run out of money is buying an annuity. This is where you take a lump sum and exchange it for a guaranteed income for life.

Inevitably, the earlier you buy one, the lower the income you will receive as it will have to last for longer.

For example, if you used £100,000 to buy an annuity with protection against inflation, you would get £4,207 if it started from age 55, according to figures from investment platform Hargreaves Lansdown. However, you could get £4,634 from age 60 or £5,304 from age 65.

Alternatively, you can keep your pension and inheritance invested and take money only as and when you need it – a process known as drawdown.

You may end up better off using this method over buying an annuity because money that remains invested can continue to grow. However, there is a greater risk of running out of money if you don’t achieve the investment returns you were hoping for.

But you could make your inheritance go even further by putting it in your pension, where it will benefit from tax relief.

You can put up to £60,000 into a pension or 100 per cent of your annual earnings (whichever is lower) each tax year and get tax relief – and if you have not used up allowances from the previous three tax years, you can use them too. For every £80 you put into a pension, the taxman tops it up to £100 if you’re a basic-rate taxpayer. If you’re a higher-rate taxpayer, you need only put in £60 and the taxman adds £40.

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However, if you have already started drawing from a pension, the amount you can subsequently put in is restricted, so check the rules and re-evaluate your own circumstances before going ahead with this.

A combination of annuities and drawdown can often provide a neat solution to making the most of your money while providing security that you won’t run out.

Although most annuities cover a lifetime, there are also options that cover a set period. These are called fixed-term annuities.

For example, you could take out a fixed-term annuity for your years of early retirement to cover you until you receive your state pension.

At that point, you could opt for drawdown if you prefer, with your state pension providing the bedrock of your income.

Or you could buy another annuity that takes into account your new income needs now that you have your state pension coming in.

A decent financial adviser can set you up with an investment portfolio designed to last for a longer retirement and make recommendations about how annuities could help.

They can also advise on keeping your tax bill in check and help you to plan if you want to pass on an inheritance to the next generation.