What do the new pension freedoms mean to your retirement planning? Do they provide the final piece of the jigsaw to your financial plan to allow early retirement? Or are they simply confusing and overwhelming?
For the vast majority of those looking for financial independence the answer is very much both – and at the same time as well. If you are planning to retire, you now have serious and complex decisions to make about your financial future.
Without proper financial planning, outliving your income stream has become a significant risk. If you’re part of a married couple and both of you are 65 years old, there is a 66 per cent chance that one of you lives to be at least 90 years old. Whilst people are living longer, this doesn’t necessarily mean they continue to be healthy for longer.
Thinking about retirement planning for many people is likely to lead to a headache! There are so many factors to think about and few over which you have total control, such as your rate of saving and spending or the risk you take in your portfolio. Other factors over which you might have some degree of control, such as the duration and earnings level of your employment, particularly as a business owner and your own longevity. Finally, there are a range of factors over which you have no control, such as market returns.
Knowing that a wide range of variables can determine financial security in retirement, understanding retirement spending and planning accordingly is critical.
This leads us to two potential models for ensuring you don’t run out of money in retirement.
The first involves a so-called ‘bucket’ method. Your assets are arranged into three buckets according to time horizon, with the short-term portfolio regularly tapped for spending invested in cash and cash alternatives. The medium-term portfolio can be invested in slightly higher-yielding assets, such as dividend-paying stocks and shares. The third bucket in the portfolio can be reserved for riskier, higher-return strategies or for longer-dated savings instruments. Such a model can certainly help investors to grow wealth over time while maintaining spending to support their lifestyle, but at best it is an inexact rule of thumb.
A second model for structuring a retirement income involves a triangle. Starting from the base of the triangle you move up the spectrum of risk and return. The bottom and largest portion of the triangle comprises needs – the basic assets that are needed to cover regular expenses. The income sources at the bottom tend to come from pensions, individual savings accounts, short-term bonds or cash savings.
Think of the middle of the triangle as your wants; your desired lifestyle in retirement. Sources of income in the middle of the triangle tend to come from investments in equities or fixed income.
As we reach the top of the triangle, it’s the legacy considerations, where you might be considering assets to leave to your heirs. This income can be sourced from gifts, trusts or a combination of these and other inheritance tax planning solutions that suit your particular circumstances.
Whatever your needs and wants, there is increasing evidence that there is real value in engaging with a financial planner to help you identify, create and maintain the lifestyle you want without the fear of ever running out of money.