Navigating The Retirement Income Maze
Working out how you will fund your chosen lifestyle when you will no longer be earning a living could be the most important financial planning you do. There are many ways to build up assets which can be used to generate retirement income, but having done all that, how can you be sure they will deliver what you require?
In this blog, we cover some basic principles in planning for your future. These form the basis of our initial (and ongoing) planning with our clients. I am assuming you have already done the very first step, which is deciding what you actually want to do with your time. Here are the key points:
- Figure out your cost of living – basic expenses and the fun stuff.
- Assume you’re going to live to 100+
- Recognise that your income needs are likely to change over time.
- Don’t underestimate inflation.
- Don’t forget the State Pension.
- Make sure you save enough money, then save a bit more.
- Remember to enjoy life in the meantime!
Figure out your cost of living
Whatever ‘retirement’ means for you, whether it’s a case of stopping work altogether or going part time, it’s essential to consider how much you’ll need to live on.
Estimating that is easier the closer you are to retirement. However, it is worth having a go at it as early as possible, because that at least gives you a rough target to aim for.
At the risk of stating the obvious, start by adding up all your yearly spending, not forgetting to include the annual costs like car and home insurance as well as ongoing weekly and monthly costs. Then take off any outgoings that will have stopped by the time you retire, such as mortgage payments, regular savings, pension contributions and life insurance premiums. Finally, adjust for contingencies such as if you plan to move to a larger house, which may cost more to run (or a smaller one, which may cost less).
That should give you a rough idea of how much your current lifestyle costs. If you want to go further, then think about how your life may change in retirement – less commuting, more holidays, new pasttimes? Adjust for any subsidies you get from work – for example, if you have a company car now, you will probably have to fund your own car in retirement.
Split the figure into two categories – essential spending and discretionary. Beyond the basic costs of running your home, food, the car etc, it’s up to you whether you consider eating out and holidays as essential or discretionary. What can’t you live without?
Assume you are going to live to 100+
According to the Office for National Statistics (ons.gov.uk), someone who is 65 now is expected to live to age 85-87 on average. However, there will be many people who live well beyond that age.
Plan for that eventuality. The last thing you would want is to run out of money. Also, it’s possible that your cost of living may increase as you get older. Although you may do less, you might need to pay for care at some stage, and the grandchildren will always be grateful for your help if you end up having some money spare!
Recognise your income needs are likely to change over time
Although we are all different, it’s likely that we will be most active early in our retirement, but perhaps less so later on, meaning we will probably spend more heavily in the first few years. Also, if you are retiring before your State Pension (or other guaranteed pensions) commence, then you’ll need to lean more heavily on your savings and investments in the early years, until those secure pensions take the strain.
Unfortunately, with longer lifespans, the likelihood of needing assistance with living as we age has increased. Your costs may increase again in later life should you need care.
Don’t underestimate inflation
The last 40 or so years have seen a fairly consistent fall in inflation rates in the developed world. In the early 1980s central banks set out to tame the beast of inflation, which had run out of control in the 1970s. They succeeded, and we have become used to inflation rates averaging just 1.7% over the last 10 years (CPI inflation, source ONS).
However, with enormous amounts of government spending to deal with the economic fallout from Covid-19, ultra-loose central bank policy in the form of Quantitative Easing, structural changes in the world economy and very low interest rates, there is a strong case to be made that inflation will be higher in the future.
Supposing it averages 3% a year over the long run. At that rate money loses about 25% of its purchasing power over 10 years.
So, whatever your sources of income, you will probably need them to increase over time to maintain a certain standard of living.
Don’t forget your State Pension
Although the starting age for the State Pension has moved considerably in recent years, it is still payable for 18 to 20 years based on average life expectancies and is guaranteed for your lifetime. The 2021/22 full pension for new claimants is £9,339 per year, increasing in line with prices, earnings or at least 2.5% per year under current rules (the so-called ‘triple lock’).
That, by itself, probably would not be enough to live on for most people. However, if a couple both have full pensions, then their combined income would be over £18,000 a year, which could go a long way to meeting their basic costs of living.
If you wanted to buy a guaranteed pension to pay £9,339 per year, with annual increases to match inflation, starting at age 66, it would cost you about £352,000, as of January 2022 (Source: Exchange).
It’s worth obtaining a State Pension Statement, to check you are on track for a full pension. You can apply for a forecast here.
Make sure you save enough money, then save a bit more
How much is enough? That is the key question we seek to help our clients answer, and then we help them get there, navigating the rules and the markets and adjusting as their situation and needs evolve over time.
If I have learned anything, it is that it is better to overshoot your target than to fall short. You have many more options, and a lot less stress.
If you would like to have a further chat, and start building a plan for your future, please do get in touch.
The above is provided for information purposes only and is not intended to be financial advice or a personal recommendation to take any particular action. The figures given are estimates. If you are unsure about the suitability of a particular investment you should speak to an authorised financial adviser. The content is aimed at UK residents only.
All information is based on our understanding of current law and practice, which may be subject to change in the future. Tax treatment may depend on your individual circumstances.
Past performance in not an indication of future performance. Any investments you make can go down as well as up – you might not get back the full amount invested.
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