Pensions Freedom - 6 Practical tips

Posted by Kevin @ Financial Resolutions on 1st April 2015

1. Estimate how long you will live.

We are all living longer, the average 65-year-old man in the UK is now expected to live until 86 and women until 89. It’s important that baby boomers think very carefully about how they will sustain their income through a much longer retirement than previous generations.

In the table below you can see your expected life expectancy if you have attained a certain age. It is based on historical mortality rates from 1981 to 2012 and assumed calendar year mortality rates from the 2012-based principal projections.

UNITED KINGDOM LIFE EXPECTANCY

Attained age in 2015 (years)

Cohort life expectancy in years Males

Cohort life expectancy in years Females

0

91.0

94.3

55

31.0

34.0

60

26.2

29.0

65

21.6

24.3

70

17.3

19.7

75

13.3

15.4

80

9.9

11.5

85

6.8

7.9

90

4.6

5.3

95

3.1

3.5

100

2.1

2.4

Source: Office for National Statistics

2. Decide what minimum annual income you can live on in retirement

Allow yourself to feel rich for all of 30 seconds and then accept that your pension savings will need to last you for 20, 30 or even 40 years. Identify your fixed living costs and then decide how much you need on top of paying for the bare essentials. The average cost of being a pensioner is £11,200 a year, according to research. The cost adds up from spending on the basics including food, clothes, travel and heating with a weekly £215 needed per head, analysis of government figures on household expenditure shows.

You might find that you want to secure this minimum income using an index-linked annuity. Many wealthier investors will use annuities or defined-benefit pensions alongside an income drawdown strategy.

3. Divide your income pots into three

I suggest that you have three pots of money for your retirement. The first pot is for essentials such as regular bills that have to be paid every month. A secure income from an annuity would fulfil this purpose, preferably rising in line with inflation. However, if you are in an income drawdown strategy you could hold two years income in cash as an ‘income tap’, making sure that you top this up with more income as you use it.

The second pot of money is your rainy day fund, for a boiler breakdown or other unexpected outlay. You could keep this in a cash individual savings account.

The other pot of money is for luxuries such as holidays and eating out and you can be more flexible with the investment strategy for this money. You could put a bit more money towards chasing growth if you have already taken out an annuity for minimum income.

4. Treat retirement as a U-shape

Most commonly, there is a U shape to retirement income needs, made up of 3 stages. In the United States they call these the Go Go years, the Slow years and the No go years.

In the Go go years, typically ages 55-75 (although this will vary a lot) you might travel the world and spend lots of money on having a good social life. In the Slow years, typically 75 to 85, your income needs drop. In later life, many people need a higher income to pay for healthcare, or residential care. However, everyone’s U shape will be different.

5. When drawing down income you face greater risks if the market falls

Irreparable damage can be inflicted on our funds if we take 'heavy' withdrawals from investments that are shrinking in value due to stock market falls. Strong market recoveries are often not enough to recover our funds.

One solution - to avoid encashing capital - is to take only the 'natural income' on your investments. The natural income is that generated by the underlying assets in our funds (dividends on shares, interest on deposits and fixed-interest securities and rent from any property), and it tends to be more stable than capital values.

6. Diversify your income sources

When you’re investing for income, you need to diversify your income sources as much as possible across asset classes and geographies. We see many investors who focus on the traditional UK income stocks such as BT, Vodafone and GlaxoSmithKline. There is nothing wrong with this approach but you also need overseas equity income exposure.

As usual with the complexities of this subject, good quality financial advice is paramount to ensure that you make the right decisions on your retirement planning throughout your working career, as well into and through your retirement years.

This blog is filed under the category Pension Related Blog

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