People typically have numerous plans and goals for their retirement, but too often not enough is done to financially prepare for it. We come across many people who are surprised by the amount of money that needs to be saved up. Rampant inflation has also exacerbated potential income shortfalls.
Income shortfalls
Many people approaching retirement no longer benefit from a guaranteed income in retirement via a defined benefit pension scheme. During retirement the financial situation typically changes from accumulation (saving surplus income) to one where expenditures need to be funded from your assets, such as investment accounts or rental properties.
In the example table below a couple, who are both receiving a full State Pension, have a large shortfall (almost £40,000) when it comes to meeting their total expenditure needs (eg. groceries, clothing, health, household/utility bills, insurance, taxes, property upkeep, leisure, travel and holidays).
The impact of inflation
Inflation measures how the price of a basket of goods and services changes over time. The inflation rate is decreasing, but prices are still going up (just not as fast as before). A household with an annual expenses budget of £50,000 at the start of 2021 would now need £60,000 to cover the same outgoings. That begs the question for many retirees: how much do you need for a comfortable retirement, and how do you secure a sustainable income from your savings and investments?
How much do you need for retirement?
The answer depends on individual circumstances, mainly your expected income shortfall, investment returns, inflation, and the planning horizon. Below is a simplified example over a 25-year horizon with differing investment return assumptions.
Our clients often ask us about the affordability of an early retirement. Watch out for a bigger income shortfall when retiring before State Pension payments commence at age 67. A robust financial plan can incorporate differing State Pension circumstances, large one-off expenditures (eg. gifts, family weddings or special holidays), and can also assess the impact of higher inflation, lower investment returns, or asset longevity.
Sustainable retirement income
Nowadays, retirees have the ability to change the shape of their retirement income. This can often mean allocating a higher budget for when you expect to be more active, and less for later life stages. In practice, a given amount is transferred from a pension or investment account at regular intervals, while the remaining assets continue to be invested.
The main alternative to this flexible approach is to buy an annuity from an insurance company, which provides a guaranteed lifelong income stream. Annuity rates have increased on the back of higher interest rates, but annuities lack flexibility and benefits in the event of death.
Consider tax aspects
Pensions are outside of the estate for inheritance tax purposes, so it may make sense to use other assets first during retirement. Income tax is also due on pension withdrawals (a 25% lump sum up to £268,275 can be taken tax-free), while other assets may be free from tax, depending on your individual circumstances.
Living off an asset base can be a challenge for some people. Formulating – and sticking to – a clear retirement plan helps to avoid costly mistakes and negates the risk of running out of money. The most important tasks are summarised in the below paragraph.
A timeline for retirement
In the years leading up to retirement (5–20 years in advance) it’s a good idea to optimise your savings (ISAs vs. pensions), pursue a suitable strategy across all your investable assets, think about your desired retirement timeline and budget, and create a financial plan (a professional can help you). Five years before retirement is a good time to set a retirement date, get a State Pension forecast, and formulate an income strategy (flexible withdrawals and/or an annuity).
During retirement we recommend reviewing your financial plan regularly, particularly if your personal situation changes, or in light of new tax rules. If adopting a flexible income strategy care is needed when deciding which assets to draw on and when, and how much to take. Many retirees opt to delegate the ongoing management of their investments to a professional at this stage of their journey.
It’s important not to sleepwalk into retirement. Call 03300 564 446 or get in touch via our contact form to gain a professional opinion on your retirement journey from one of our financial advisers.
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.
