Please note that tax, investment, pension and ISA rules can change and the information and any views contained in this article may now be inaccurate.
How to avoid running out of money in retirement
Running out of money before you run out of life is one of investors’ biggest fears.
Fortunately, there are lots of steps you can take before and during retirement to ensure your money lasts your lifetime.
WHY IS IT SUCH AN IMPORTANT ISSUE TODAY?
Increased life expectancy means people today are generally living much longer than they were in the past, so your money needs to last for a greater number of years.
When you combine this with a sustained period of low interest rates, it has dramatically increased the risk that your money won’t last as long as you hope.
The vast majority of people used to use their pension to buy an annuity at retirement, providing them with a guaranteed income for life.
But this trend has changed following the introduction of pension freedoms in 2015, with many people choosing the flexible income drawdown option instead of an annuity.
If you’re taking drawdown, you need to ensure your withdrawal rates are sustainable and that your investments keep growing.
HOW MUCH MONEY DO I NEED IN RETIREMENT?
An old rule of thumb was to aim for two-thirds of your working income as an income in retirement.
In reality, it depends on what standard of living you hope to maintain during your retirement.
Costs to think about include day-to-day essentials such as food, utilities and insurance, as well as discretionary spending on things like holidays.
Tom Selby, senior analyst at AJ Bell, points out that someone who has paid off their mortgage will likely have lower costs than someone who is renting.
If you want to retire early you’ll either need a bigger pot or have to accept a lower income than if you retire later.
Martin Bamford, managing director at Informed Choice, a financial planning firm, says spending patterns in retirement are unlikely to remain static.
‘In some cases, clients spend a lot less in retirement than they spent during their working lives,’ he says. ‘Other clients maintain similar spending levels, replacing some costs with others such as travel and leisure.’
HOW CAN I BUILD UP A SIZEABLE POT BEFORE RETIREMENT?
It might sound obvious, but the biggest impact you can make on your future retirement pot is to save more now.
‘Improving investment returns or reducing charges are often the focus of financial planning, but it’s putting more into savings pots that has the greatest positive impact on the end result,’ explains Bamford.
It’s worth remembering that if you’re saving via a workplace pension your contributions should be matched by your employer, and all pension contributions receive at least 20% tax relief from the Government. The amount of relief depends on your income tax band.
Katie Machin, financial adviser at Walker Crips Wealth Management, says when you’re deciding how much to save you should try to estimate how large a fund you might need at your chosen retirement age and work back from there.
‘Contribute as much as you can afford and be realistic. You still have to enjoy time now, but have a balanced attitude to this and plan for your future too,’ she adds.
It’s important to think about where you want to invest your money such as certain stocks or funds. If you’re investing through an ISA or Self-Invested Personal Pension (SIPP) you’ll have complete control over your underlying investments.
Selby says investors should decide what level of risk and short-term volatility they’re willing to accept in order to deliver long-term growth.
‘Historically, those willing to ride out short-term bumps in
the road have achieved better long-term investment performance,’ he says. ‘Generally speaking, younger savers are also able to tolerate more short-term volatility knowing they will not be accessing their fund any time soon.’
HOW DO I PRESERVE WEALTH DURING RETIREMENT?
The key thing to think about during retirement is sustainability. It’s important to ensure you’re withdrawing enough money to fund your needs, but not so much that you risk depleting your pension early.
A commonly used rule of thumb is to withdraw 4% a year from a pension pot, but this so-called ‘sustainable withdrawal rate’ will depend on a variety of factors such as your underlying investments and objectives.
‘I believe that selecting a strategy that is right for you initially is only part of the solution,’ says Machin.
‘You need to carefully monitor and review this strategy throughout retirement to ensure that if it is not working, action can be taken.
‘You must remember that income through drawdown can be varied and it is often worth considering a form of guaranteed income to meet day-to-day commitments, with drawdown designed to meet discretionary spending needs.’
One thing to consider is the impact that large withdrawals combined with poor investment performance in the early years can have on your retirement plan.
Large percentage drops when your pot is at its biggest will be harder to make up later when your capital has been eroded.
WHAT OTHER SOURCES OF INCOME COULD I USE?
If you’ve built up a National Insurance record of at least 35 years you’ll be entitled to the state pension, which is currently set at £164.35 a week. However, the rules are complicated and you may get more or less than this amount.
You might also have cash savings, an investment portfolio, property investment and dividends from a business.
Bamford says the most financially successful retirements tend to have access to income and capital from a variety of sources.
‘The ability to flexibly draw an income from different places, depending on the underlying economic circumstances, creates an opportunity for efficiency,’ he adds.