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Planning for retirement and getting the best outcome
Planning for retirement does not have to be difficult or complex and there are lots of simple and common-sense things to consider including:
- 1 Review your pension investments in the run up to retirement
- 2 Calculate out how much income will you need throughout your retirement
- Think about how long your retirement will last
- Decide when is the best time to take your tax-free cash and income
- 3 Work out how much income should be guaranteed and how much flexibility you want
- 4 Decide how much risk you want to take
- 5 Plan what will happen after your death
1 Review your pension investments in the run up to retirement
As you get nearer retirement you should be thinking about how much risk you should be taking. This can be tricky because on the one hand you want to benefit from any investment growth but on the other hand you don’t want to see your savings fall in value if there is a stock market crash.
2 Calculate out how much income will you need throughout your retirement
You may view the idea of budgeting a daunting exercise but once you have done it you will be in a much better position to work out how much income you will need and where it will come from. By far the best way is to prepare a projected cash flow showing all your planned expenditure. You can then work out where the income you will need will come from, for instance your state pension, private pensions or savings.
Don’t forget to take account of inflation as this reduces your spending power over time and don’t forget your income requirements may change over time, for instance you may not spend as much during the middle part of your retirement.
Think about how long your retirement will last
Most people underestimate their own life expectancy by several years which means they don’t realise how long their retirement may last. For instance, a man aged 60 can expect to live another 26 years to age 86 and a woman of the same age can expect to live age 88.
The reason why it is important to think about how long you might live is simple maths. If you have a certain amount of money at retirement you need to work out how to spend to so that you don’t run out of money. If you only think you might live another 15 years but you actually end up living for another 20 or even 25 years this will dramatically change your retirement calculations.
It is not just how long you think you will live, but the quality of life and your health. For instance, many people are living longer but in poorer health, which means that you might want to factor in the need for more income to pay for medical expenses and care in later life.
Decide when is the best time to take your tax-free cash and income
Although it might be tempting to dip into your pension pots as soon as you reach age 55 (currently the earliest you can take money out of your pension), it is normally better to wait until you stop working or you really need the money.
You should also think about tax because it does not make sense to pay tax on income you don’t need if you can leave it grow tax free and take the income later when you end up paying less tax.
3 Work out how much income should be guaranteed and how much flexibility you want
This may seem like a relatively simple question, but it is probably one of the most important decisions you will make as it goes to the heart of retirement planning.
A popular and useful planning technique is to build an income pyramid. The wide base represents your essential spending and should be guaranteed as far as possible. At the very top of the pyramid is the luxury spending which doesn’t have to be guaranteed and in the middle is the discretionary spending such as holidays for which you probably want some flexibility.
The pyramid approach may seem simple and obvious but it helps demonstrate another very important financial planning concept: “Don’t put all of your eggs in one basket”. In many cases there is an advantage in having a combination of annuities and drawdown.
- Annuities = guaranteed income with no risk of outliving the income
- Drawdown = income flexibility and investment control
4 Decide how much risk you want to take
Generally speaking, you should take enough risk to avoid being locked in very low returns for evermore but not too much risk that you put your future retirement plans in jeopardy.
When assessing how much risk to take you should consider not only your attitude to risk but also your capacity for loss.
Attitude to risk is an easy concept to grasp and is normally expressed as low risk, medium risk or higher risk (see table below). Your attitude to risk is normally measured as your tolerance to taking investment risk and we have special questionnaires and tools to help assess your risk profile.
Capacity for loss is described as your ability to absorb falls in the value of your investments or income without it causing you adverse financial hardship or emotional strain.
5 Plan what will happen after your death
Basically, you have two choices. You can you decide in advance how much income will be paid to your spouse or partner by purchasing a joint life annuity.
This means that if you die first a percentage of your annuity income will automatically continue to your partner for the rest of their life.
The alternative is to arrange for your spouse, partner or any other beneficiary to get the money from your pension pot to spend as they wish. They can leave money to other people after their death. In both cases, and money paid out will be tax free if you die before age 75, after that they will pay tax at their marginal rate on any money taken out.
If you want to make the most of pension freedoms you should start planning ahead and make sure your financial affairs are in good shape in the years running up to retirement.William Burrows
Call: 07730 435 657
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LEEDS, LS2 9DF