Reaching retirement is a huge milestone for anyone. If you’ve been able to build up a significant retirement pot in a pension, have other savings such as ISAs or investments, or maybe a combination of all three, you may feel like you’re set for the rest of your life and can live your retirement in the lifestyle to which you’ve become accustomed.
However, every now and again, it may be that you need to take a ‘reality check’.
CHECK #1 – LIFE EXPECTANCY
Life expectancy has increased dramatically over the last 100 years. In 2016, there were 1.5 million people over age 85, a figure that is set to increase to 3.4 million by 2040. The next 20 or so years will also see a significant shift in the number of people reaching age 100. In 2016, there were 14,450 individuals over 100 but it is forecast that nearly one in five people currently living in the UK will reach their 100th birthday.
All of these figures mean that if you retire at 60, you may feasibly have another 30 or 40 years to live – a fact that is changing the landscape of retirement planning. Where a pension may previously have had to support an individual for 15 or 20 years, retirement pots now need to last longer and deliver more than they ever have – and all of this against a backdrop of inflation at an above-target rate.
CHECK #2 – SPENDING
You may think that your plans for retirement are fairly modest but when it comes to it, many clients can quickly and easily become carried away. Whether it’s helping family onto the property ladder, funding school fees for grandchildren or enjoying your new-found freedom by taking numerous holidays per year, if the percentage you are drawing from your pension pot is higher than the interest you are earning on it, you don’t have to be a rocket scientist to figure out that your funds will begin to deplete. And quickly.
This is notwithstanding the cost of unplanned expenses – such as care home fees – which can rapidly diminish savings even further.
CHECK #3 – WITHDRAWAL RATE
So what is a sensible withdrawal level to aim for to decrease the pressure on your portfolio and improve its long-term sustainability? For a long time, a figure of 4% pa has been considered ‘the magic number’. This is partly derived from the target level of return expected on pensions and investments during retirement as clients often de-risk their portfolios when they no longer have the ability to earn and top up their pension. In moving their portfolios into a more cautious position, the effect is to reduce the potential rate of return they might be able to expect. Many say ‘the magic number’ should be adjusted down now to a more realistic 2.5% pa, factoring in charges, advice fees and projected growth rates.
Arriving at a target level of withdrawal of course depends on the size of your pension pot and whether other monies are available. For a moderately sized pension of £500,000, 4% equates to £20,000 gross (i.e. before tax) a year – a figure perhaps way below the amount you may have been used to receiving when you were working.
Therefore, without making adjustments to expenditure or lifestyle, it may be tempting to up withdrawals. But even adding one or two percent to your annual withdrawal rate can knock years off the length of time your pension may last.
In the past few months, we’ve seen a number of clients drawing from their capital at rates closer to 10% or 12%, clearly therefore putting strain on the sustainability of their portfolios.
Although we may want to treat ourselves in retirement or help our children – and rightly so after spending years working – there is ultimately a fine line between enjoying retirement and risking running out of money.
So how can the conundrum be solved? As with many matters we deal with, it comes down to having a sensible plan and sticking to it – something that requires a level of discipline.
This is where we come in as financial advisers. It’s our job to ensure that clients make informed decisions regarding their money and that they are fully aware of the impact that withdrawals may have on their overall portfolios. We have a number of tools at our disposal to help us forecast the longevity of a portfolio, putting the figures into perspective for clients. We would much rather be able to use these tools as a way of helping clients to plan their retirement effectively rather than needing to prepare projections that give a short, sharp shock on how little time a pension may have left after years of heavy withdrawals!
Part of the solution is about changing mindset. Reaching retirement and being able to access your pension pot shouldn’t be seen as a windfall. Even those with retirement pots in the upper realms of the Lifetime Allowance need to be realistic about their withdrawals and take advice on their options during both the accumulation and decumulation phases to ensure they make the most out of their own personal circumstances.