How do you responsibly withdraw income from your pensions once you retire? If you are not careful, excessive withdrawals can risk you running out of money in retirement. Nearly 48% of savers worry about this outcome. Yet the good news is that much can be done to avoid such a scenario. Moreover, the earlier you start planning, the better.
In this article, our Carlisle financial advisers discuss how investors can avoid pensioner poverty and make provisions for a sustainable, comfortable retirement lifestyle. We hope these insights are helpful. Please contact us for more information or to speak with a financial adviser:
t: 01228 210 137`
e: [email protected]
The uncertainty of the future
Before addressing this question directly, it is important to discuss another (prior) one first. Namely, what is more important to you – leaving a rich legacy (inheritance) to your loved ones when you die? Or, do you want to live the “richest” life possible whilst you are still alive?
These objectives can be balanced to a degree. However, many clients will need to prioritise one over the other. For instance, perhaps an individual focuses on the second objective, thinking: “If there is money left over for my family when I die, so much the better”. There is nothing wrong with this. Yet, it is important to consider the financial risks.
Most people in the UK have working lives that can be divided into two phases. The first is called “accumulation” and refers to the gradual building of retirement wealth (e.g. via pension contributions). The second is called “decumulation” and is when an individual switches strategy – i.e. away from wealth building and towards extracting an income from that wealth.
However, the challenge with all of this is the uncertainty of markets. If your pension investments do well (perhaps better than expected), you may enjoy a better retirement lifestyle than you originally planned. Conversely, if they underperform, you might face a smaller fund than you wanted. Unfortunately, you cannot control what happens in the markets. However, you can control what you choose to invest in and how much you save.
The hidden picture of retirement savings
When most people retire in the UK, they tend to rely on pensions to provide a replacement income for their salary. This can be imagined to be a bit like a petrol tank. Over a career, your pension contributions slowly “pour” into the tank until you deem it “full enough”. When you retire, you begin slowly opening the tap to “fuel” your retirement lifestyle. The question is, will the tank “run out” before you die?
There are two crucial factors to consider here. The first is inflation. Over time, the general price level is likely to rise, making goods and services more expensive. The “buying power” of £1 saved in your pension(s) will slowly erode. Your retirement plan needs to account for this. For instance, £100,000 might sound like a lot of money in 2024. However, what will it be worth in 30 years’ time? To preserve the fund’s “real value”, it needs to at least grow in line with inflation.
The second factor is your withdrawal rate. To take the above ‘petrol tank’ analogy again, the more powerful the “tap” is turned on, the faster the tank will deplete. Similarly, the faster you sell investments in your pensions (to gain the cash needed for your income), the quicker your retirement fund will run out. Therefore, your withdrawal rate needs careful management throughout retirement to help avoid pensioner poverty.
How to not run out of money in retirement
The best way to secure peace of mind about your retirement plan is to seek professional financial advice. However, here are some general ideas to think about before your meeting:
- Consider the “4% Rule”. This is often a good starting point for getting an idea of a “safe withdrawal rate” in retirement. For instance, if your nominal rate of return (for your pension investments) is 8%, then its “real value” may be reduced by 2-3% due to inflation. This leaves a 5-6% return in real terms. If you withdraw 4% that year, then you could draw an income whilst keeping within the average real returns of your pension. More recent studies, however, have suggested that 4% might be too high, especially if a person is considering early retirement. These are questions that a financial adviser can help you consider. How much income do you need in retirement? And can my pensions provide this income throughout my retirement?
- Consider “sequencing risk”. The 4% Rule is quite rigid and cannot be fully relied upon to establish longevity of your pension(s). A lot could “go wrong” over your retirement. Perhaps inflation skyrockets (as it did in 2022, at 11.1%) or the world enters a global recession impacting investment markets. Here, it is important to think about sequencing risk. This points to an important dynamic: i.e. a large loss in early retirement will likely be more detrimental than one in late retirement. Managing this risk will be crucial for ensuring the sustainability of your fund(s).
A financial adviser can help you devise an appropriate strategy to protect yourself. This might involve buying an annuity and/or following tailored “withdrawal rules” to account for different market conditions and economic circumstances. This can maximise the possibility that your pensions can provide for you throughout your retirement.
Invitation
If you would like to discuss your financial plan and investment strategy, then we would love to hear from you. Get in touch with your Financial Planner here at Vesta Wealth in Cumbria, Teesside and across the North of England.
Reach us via:
t: 01228 210 137
e: [email protected]
This content is for information purposes only. It should not be taken as financial or investment advice. To receive personalised, regulated financial advice regarding your affairs please consult your Financial Planner here at Vesta Wealth in Cumbria, Teesside and across the North of England.