The annual amount of income a UK couple need for a ‘comfortable’ standard of living in retirement is £49,700 per year, according to recent research conducted by the Centre for Research in Social Policy on behalf of the Pensions and Lifetime Savings Association. ‘Comfortable’ denotes a standard of living that would afford “more financial freedom and some luxuries”. At the other end of the scale, £16,700 a year would be enough to secure a ‘minimum’ standard of living for a retired couple, according to the research. A single person would need £33,600 a year to ensure a ‘comfortable’ retirement living standard.
How much do you need for retirement?
Retirement planning depends on individual circumstances. There are several contributing factors, including asset base, spending needs and goals, state of health, and your tax situation. Spending requirements are dictated by the desired lifestyle of a couple or individual. Spending can often be higher in the earlier years of retirement. For example, more may be spent on holidays or hobbies while retirees are in good health. There are many ways in which a couple or individual can utilise their pension and other assets to optimise retirement income. Careful planning and/or financial advice will help to minimise tax liabilities and ensure assets stand the test of time.
Drawdown vs. annuity
Flexible drawdown allows pension holders to dip into their pension pot as and when they require cash, and keep the remaining funds invested. Another option is to buy an annuity from an insurance company. A lifetime annuity provides financial security, as it affords the policyholder a guaranteed income for the rest of their life. However, this option affords less flexibility than drawdown, and annuity rates are currently very low, so there is a risk that you might not get back your initial investment.
In the example below a retired couple, both aged 65, have £750,000 in their combined pension pots. Opting for drawdown could allow them to collectively take an inflation-linked £43,500 per year as income for the following 20 years (assuming investment returns of 4% per year and 2.5% for inflation) if they passed away at the age of 85, or £27,500 annually if they were to live until they were 100. Buying a joint-life annuity (assuming an inflation-linked payment protection increase of 2.5% per year) with the whole pot would provide guaranteed income of £21,500 per year, regardless of how long the couple lived for.
The risks of flexible retirement income
Running out of money is one of the main risks associated with taking a flexible income approach in retirement. Care is needed regarding both withdrawal amounts and timings. Timing is a particularly important factor in the early years of retirement. Market declines combined with poorly timed withdrawals can erode the long-term value of an investment portfolio, leaving you unable to meet future income needs. This is known as ‘sequencing risk’.
According to the Office for National Statistics, the average life expectancy of a 60-year-old is 25 years for females and 23 years for males. The table below shows scenarios for the asset base required to reach age 95, based on different retirement ages and annual income. For example, someone retiring at age 60 and requiring £50,000 a year in income would need assets of £1,355,000 to fund their spending needs over a 35-year period. The impact of inflation over a lengthy period of time means that you require more money to maintain your desired living standards. Your income requirements would double over a period of 30 years, assuming 2.5% inflation a year.
It’s also important to note that the longevity of your drawdown asset base is closely linked to investment returns. The chart below shows the impact of differing investment returns over a 40-year timeframe, starting from an asset base of £1,500,000, and assuming £50,000 annual spending needs (which will increase in line with inflation). A lower investment return of 2% could see funds run out within 27 years (assuming 3% annual inflation). This is in contrast with a 5% investment return, which would see £1,725,000 available at 27 years, and almost £880,000 remaining at the 40-year mark.
Other considerations
Because pensions are outside of the estate for inheritance tax purposes it may make sense to use other assets first. Income tax is also due on pension withdrawals (a 25% lump sum can be taken tax-free), while other assets may be free from tax, depending on your individual circumstances.
A financial adviser can help you understand your income needs and plan effectively for retirement. Speak to a Lumin expert on 03300 564 446 to find out more, or get in touch via our contact form.
This article is for general information purposes only and does not constitute financial advice or a personal recommendation. Past performance is not a reliable indicator of future results. Investments can rise or fall in value, and you may receive less than you originally invested. Tax treatment depends on individual circumstances and may change in the future.
