I have recently been re-watching the US TV Series ‘Breaking Bad’ (yes, it is that good). For those not familiar with the show, it tells the story of Walter White, a struggling high school chemistry teacher who, when diagnosed with lung cancer, turns to a life of crime making and selling ‘crystal meth’ to try and secure his family’s future before he dies. Now, whilst I’m not going to get in to the ethics of his venture, one question that Walter frequently asks himself is, ‘how much is enough’? This is a question that many clients ask me when planning for their retirement, especially when they don’t have the luxury of a company pension scheme to fall back on.
How big a pot of cash do I need to have a comfortable retirement?
‘How much’ will differ from client to client as everyone has different means and aspirations. The average UK salary in 2016/17 was £26,500pa and the new State Pension is currently £8,546pa. Whilst for most this is not payable until age 67, if you qualified for the full payment then this would leave a further £17,954 to be provided by other means, assuming your objective was to fully replace your income in retirement. So, for the purpose of this exercise, let’s start by seeing how large a fund you would need to provide £18,000pa in retirement.
The next question is ‘when are you looking to retire’? The traditional retirement age has previously been 65 as this coincided with the state pension age, but as we have already seen, the state pension age has now been put back to 67 (and will be pushed back to 68 by 2044). In the majority of cases the earliest you can access funds from an authorised pension scheme is age 55. Increasingly we are seeing clients look at ‘staged retirement’ – moving from ‘full-time’ to ‘part-time’ employment for the years between age 55 and 67. Certainly, the earlier you are looking to draw on your pension, the smaller the income you will receive (or the larger the fund you will require). Whilst income flexibility is increasingly desirable and can be achieved, it does bring in added risks. For illustrative purposes here and to help demonstrate how the retirement landscape has changed over the years, I will assume the full £18,000pa income is required at age 65.
If a 65 year-old male wanted a guaranteed income of £18,000pa for life today, paid monthly in advance on a level basis and guaranteed for 5 years, the top annuity rate is currently 5.49%. That would mean he would need a fund of £327,690 to achieve £18,000pa.
The fund would be paid to an insurance company in exchange for an income for life that would never increase and, after being paid for at least 5 years, would cease on death.
If the same individual wanted the pension to increase each year to provide some inflation proofing (say 2.50%pa) and wanted half the pension to continue for their spouse should they predecease her, the rate reduces to 3.21%. The fund required now increases to £561,447 but there is now some spousal provision and the income will rise each year.
As already mentioned, increasingly clients want some income flexibility in retirement and look to utilise routes such as ‘flexi-access drawdown’ rather than using the fund to purchase a ‘pension annuity’. In such cases the fund remains invested throughout retirement and the client draws down an element of the return each month to provide their income. On death, whatever fund value remains can be passed on to spouse and other beneficiaries. The price for the added flexibility is ‘risk’ as there is no guarantee that the fund will deliver the return needed to generate the required level of income. Furthermore, there are management charges that will reduce the returns being made.
For this reason, if you desire a sustainable income, the absolute maximum rate of draw down that I would recommend from such schemes for someone at age 65 is 4.50% (for a client at 55 this would reduce to 3.50%).
So, whilst the route has some additional benefits that can be attractive, the rates of return are not too dissimilar to the annuity rates previously quoted. For someone wanting to generate £18,000pa income at age 65 via ‘Flexi-Access drawdown’ a £400,000 fund would be required. (At age 55 this increases to £514,285).
The pension landscape has changed considerably over the years driven in part by us all living longer, combined with falling annuity rates. Some clients may be lucky enough to have a Final Salary or Defined Benefit pension scheme where a guaranteed, increasing income is provided by the Pension Scheme Trustees. Here, all the risks are taken by the scheme and the employee receives a guaranteed pension at retirement age based on the number of years they have been a member of the scheme. The rising mortality rates and falling annuity rates have added enormous pressures to these schemes, causing many to close. Increasingly clients need to fund their own retirement using Personal Pension or Self-Invested Pension Plans. Within these, the size of the fund is dependent on the amount invested, the investment returns achieved and how long is available for the capital to be invested prior to being drawn as a pension.
To demonstrate how the pension landscape has changed, in 1990 a male age 65 would only have needed a pension fund of £116,129 to generate £18,000pa as the equivalent annuity rate was 15.50%. The downside was that the average life expectancy was 78.
Today, the average male aged 65 has a life expectancy of 84 years of age.
We should probably also mention that the rate of inflation in 1990 was 7.49% and today the Retail Price Index is 3.20% so despite what you may feel, your money does go slightly further today. The average UK salary in 1990 was also only £13,760pa (with the full state pension being £3,905pa), so investment fund expectations were somewhat smaller.
So, ‘how much is enough’? Well I think the short answer is ‘as much as you can afford’. I have based my comparisons on a client retiring at age 65 but in the majority of cases, out of desire or necessity, a phased retirement starting as early as 55 is increasingly common. So, unless you are the next ‘Walter White’, to achieve your retirement goals ‘retirement planning’ is essential. What provision you already have needs to be regularly reviewed. How is it performing? What charges are you paying? Is the performance and associated costs competitive? Is the investment risk you are taking appropriate?
At Choice Financial Solutions we will sit down with you and put together your retirement plan. We will review all your existing provision and ensure your money is working for you in the most cost-effective way. ‘Pension Plans’ remain a very tax-efficient way of saving for your retirement. Yes, the amount you need to save to achieve the retirement you desire may have increased, but you are likely to enjoy a far longer retirement than earlier generations so the sooner you make an appointment to put together your retirement plan, the better. To make an appointment, get in touch here, or call us on 02380 633636.
John Quaif is an Independent Financial Adviser and the Director of Choice Financial Solutions. He has been advising clients for over 26 years and has many industry qualifications which his clients benefit from on a daily basis. Heading up the Financial Services team, John works with our high net worth clients and specialises in pension transfers and portfolio management.
This article is for information purposes only and should not be taken as advice. All retirement planning advice is based on your individual circumstances.