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Point of View

Funding a long retirement

With falling annuity rates, disappearing final salary pensions and increasing longevity, how can you develop a better plan for later years.

 

Retirement has changed dramatically and while previous generations lived through a golden age of final salary pensions and high annuity rates that guaranteed an income for life, these options are no longer available to most people.
 
Future generations of pensioners will have to fund their retirements from the money they have saved throughout their lives and they may have to do so for much longer than their parents did. Lifespans have extended and someone who retires today can expect to live for six or more years longer than someone who retired in 1960, meaning many may not have prepared financially for such a long period. A 65-year-old man retiring today can expect to live to 83 and a woman to 85. 
 
So how can people prepare to enjoy the lifestyle they always wanted in retirement? Financial Planner Carl Drummond says: “We no longer have the traditional sort of retirement we had 20 or 30 years ago. What used to happen then was that people would retire with their defined benefit pension or, if they weren’t lucky enough to have one, a money purchase scheme, which they would typically use to buy an annuity.
 
“These days, due to annuity and interest rates being so low, people need to look at other avenues that are more flexible. And pensions have migrated into something that can be useful for ongoing retirement planning. So rather than just buying an annuity, which is quite unlikely for most people, you need to think of your pension pot as a long-term investment because rather than needing to last only 15 to 20 years, it could be as long as 20 to 30 years now.”

What has changed?

If you look back to the swinging sixties, retirement was a well-defined process, in which men retired at 65 and women at 60, when they began drawing the state pension and company pensions, which were mostly final salary (defined benefit) schemes. By 1967, eight million employees working for private companies enjoyed a final salary pension, as did four million workers in the public sector. Once retired, men in 1960 could expect to live another 12 years to 77 and women to 80.
 
The pensions landscape is very different today. There is no longer a default retirement age and workers can choose when to retire. Generous final salary pension schemes have mostly given way to defined contribution schemes. By 2011, there were only about 1.6 million people actively contributing to a defined benefit scheme in the private sector. These days there isn’t a single FTSE 100 company that provides a guaranteed pension based on final salary that remains open to new entrants.
 
There is also a sharp difference in contribution rates between defined benefit and defined contribution schemes. A 2013 survey by the Office of National Statistics revealed that the average contribution rate for a defined benefit scheme was 5.2% of pensionable earnings for members and an employer contribution of 15.4% – a total of 20.6%. For private sector defined contribution schemes, the average rate was 2.9% for members and 6.1% for employers – less than 10%.

Poorer in retirement

So future pensioners face being considerably poorer than their predecessors because of a perfect storm of smaller pension pots, lower state pensions and the need to provide an income for longer.
 
And although positive in many ways, new pension freedoms introduced in 2015 mean that there is no need for people to use their pension savings to provide a retirement income at all; they could simply use the money to buy a Lamborghini, as former pensions minister Sir Steve Webb once put it. So far, the evidence suggests that people are using these new freedoms wisely, but it remains possible that some could run out of money in the future.
 
In Australia, for example, where very few people buy an annuity, nearly half of Australians have exhausted their pension savings by the age of 75. The Australian pensions environment is quite different to that in the UK, however.

Building a pension pot

So how can you set about building a pension pot that is large enough and then managing it to ensure that you have enough to maintain your lifestyle in the future? Drummond says: “Starting to save early is key. If you start saving money early, it has got more time to grow. If you leave it too long you’re going to have to make much higher contributions to your pension.
 
“It’s important to establish your goals. Work out how much money you will actually need in retirement. The starting point of that is to look at your current expenses and then estimate your future expenses by cutting out the things that should have been paid off. By the time you retire, for example, your children may have moved out, there won’t be any school fees and hopefully your mortgage will be paid off. Look at what your essential expenses and your discretionary spend will be in retirement and then work out how to fund it through retirement planning.”
 
It’s a complex process and for most people it will be essential to take financial advice if they are to take their income in the most efficient manner, mitigate any volatility in the investment markets and ensure that when they draw down money, they do it in the most tax-efficient way.

Managing retirement income

Everyone’s situation is different in retirement and there is no one-size-fits-all solution to ensuring that your pension pot will last your lifetime. Here are some general principles we follow at Sanlam but it’s important to talk to an adviser about your specific circumstances.
 
Don’t invest all your capital
It may be sensible to keep some cash or low volatility assets like corporate bonds so that you have access to enough money for two to three years, in case the markets fluctuate.
 
Match assets to liabilities
An adviser may be able to help you invest in assets such as shares or bonds that will provide dividends or income to match your expenses, while your capital grows.
 
Don’t rely on conventional wisdom
Some people might suggest putting all your money into ultra ‘safe’ assets such as gilts but even these sometimes generate negative returns and inflation may erode their value, so it may be better to invest in a range of asset classes.
 
Grow your capital if you can
It’s important to strike the right balance between risk and reward. Even when you are retired, there may still be opportunities to grow your money.
 
Don’t pay more tax than you need
An adviser can suggest ways to limit tax by, for example, using your ISA first, because there is no capital gains or income tax to pay, while leaving your pension, which might have inheritance tax benefits.

We can help you build a comfortable retirement. Speak to your financial planner to find out more or get in touch.

For information only, not to be considered financial advice.

Investing involves risk and the value of investments and the income from them may fall as well as rise and are not guaranteed. Investors may not get back the original amount invested.