We all imagine a retirement rich in sun-soaked holidays, cultural experiences, rounds of golf and memberships at luxury leisure clubs. However, many people we meet have unrealistic expectations of what their savings and investment pots can provide.
Why is this? There may be many reasons, however, in my view a failure to understand how expensive retirement income actually is means that people fail to prioritise their retirement and do not act early enough to build up sufficient capital.
The average pension saving for those surveyed aged 45-54 is £71,342 (LV State of Retirement 2017). According to current life expectancy figures, this amount may have to fund a retirement of 30 plus years, meaning fund values of this size will be unlikely to provide a sufficient amount of regular income throughout this period.
To put this into context, a 65-year-old male in good health with a fund of £500,000 could purchase a guaranteed income for life via an annuity totalling £12,426pa (assumes 3.00% annual increases) or £20,051pa (assumes no annual increases). This equates to 2.49% or 4.00% before deduction of tax. Figures include a 50% spouse’s pension. (Aviva 2019).
Rules introduced in 2011 abolished the requirement to buy an annuity, and income drawdown strategies became more available to a wider audience following ‘pension freedom’ changes in 2015. Allowing you to leave your pension invested and elect to take income from it as and when you need to, income drawdown pensions have rapidly increased in popularity. Further benefits, in addition to flexible withdrawals, include a far greater ability to pass on wealth to future generations tax efficiently. However, unlike annuities, income is not guaranteed.
Therefore, in order to ensure the money lasts a lifetime the rate of withdrawal needs to be sustainable. The Faculty of Actuaries 2018, found that a consumer in normal health who enters drawdown at age 65 has a high likelihood of generating a sustainable income if they withdraw 3.5% per annum, falling to 3% per annum if funds are drawn from age 55. Returning to the average pension pot, these figures equate to £2,497 per year at 3.5% or £2,140 at 3%. Clearly, these amounts will not go very far for the vast majority of people.
These figures clearly indicate that there is a huge misconception relating to how much is needed to support income throughout retirement. However, exactly how much you’ll need will depend on personal circumstances, the availability of other forms of income and your health. Other factors that may or may not be within your direct control include your cost of living, lifestyle choices and your health.
With all of this in mind, whilst retirement might not be a fun or sexy topic of conversation, if you want to ensure that you are on track to attain the lifestyle you envisage in retirement, it is a necessary one. So what should you do? Start to build a financial plan by following the steps outlined below.
Step one – build a personal balance sheet
Establish where you are now by obtaining valuations of all your savings, pensions and investments. It’s important to get a comprehensive view of all the sources of income you will have available at retirement – income does not have to come from pensions alone.
Step two – complete your own cash flow forecast
Create a retirement budget by quantifying how much you need to meet:
- Regular committed expenditure – e.g. household, transport, healthcare, insurance and food costs.
- Discretionary expenditure – e.g. club memberships, theatre tickets, socialising.
- Regular large item expenditure – e.g. holiday costs and replacement cars.
- Other financial commitments that coincide with, occur close to your retirement date or during your retirement – e.g. helping children purchase properties, helping elderly relatives or grandchildren and planned home refurbishments.
Step three – Quantify your shortfall
You should now have your net asset position and your budgeted cash requirement. This information should help establish how well placed you are to retire at your chosen date.
Step four – Take appropriate action
If you are likely to face a shortfall there are things you can do.
If you have a business, working on its valuation might be one option.
Individuals and business owners should also consider taking action to direct surplus income and cash to tax efficient savings vehicles. Pension contributions provide fantastic opportunities to mitigate corporation tax liabilities and offer employed individuals the opportunity to reduce their liabilities to income tax. When made regularly alongside ISA contributions, individuals can build tax efficient portfolios capable of delivering a large proportion of income without much liability to income tax.
However, this can only be achieved with a commitment to a plan which is reviewed regularly to ensure you are on track. The sooner you act, the cheaper your retirement income is likely to be because funds have a longer period of time to grow.
The FCA (Financial Conduct Authority) does not regulate tax planning. The contents of this article are for information only. The article does not constitute individual advice. The value of investments and income derived from them can fall as well as rise. You may not get back what you invest.