A secure pension income for life is no longer a reality for most people. While some retirees are fortunate enough to have built up a substantial defined benefit pension, most will need to manage their retirement with care, drawing an income from a number of different sources.
In the early years of retirement, the focus is on ensuring that you have enough income to cover your expenditure whilst you adjust to your new lifestyle. There may also be other significant expenditure as you take up new hobbies or travel. However, in the later years of your retirement you may become concerned with the cost of care and ensuring that you are able to leave a wealth legacy to your family.
Balancing these goals and priorities can be difficult and significant planning may be required to ensure that you meet your goals.
So how can you preserve your wealth in retirement, and make sure that your money outlives you?
Have a plan
The starting point is understanding what you would like to achieve, and to do this, you will need to have a rough idea of your spending requirements. For example:
- Essential living costs
- Ad hoc capital expenditure such as home maintenance or replacing cars
- Discretionary and luxury spending
- Gifts
- Medical and care costs
You should also work out your various income sources, such as:
- Pension schemes from your former employers
- The state pension
- Rental income
- Investment income
In addition, you should also list any cash, pensions, and investments that you could use to fund your retirement. If you still have a mortgage, don’t forget to account for the monthly repayments or clearing the capital.
A cashflow plan can help you work out if your retirement goals are sustainable based on the income and assets you have available.
Keep enough cash
As a rule of thumb, the minimum amount of cash that you should keep hold of as an emergency fund is around three to six months’ worth of expenditure. This can be used in any unexpected situation to cover any cash flow shortage that you may have.
In addition to your emergency fund, you may find that you need to top up your income from capital, either on a regular basis or ad hoc.
Selling investments at short notice can impact your long-term returns, particularly if the market takes a downturn. It is far more efficient to plan any encashments well in advance and you should aim to keep a minimum of one year’s spending requirements in cash to cover your day to day spending.
If you are investing a lump sum, you should avoid investing any capital that you are likely to need within five years, as if the market dips (as it does on a regular basis), your portfolio will have less time to recover.
Invest (and disinvest) tax efficiently
You don’t need to start drawing your pension immediately when you retire. In fact, it can be far more tax efficient to leave it invested and use other assets instead. Pensions can be passed on to your beneficiaries free of tax if you die before age 75. After age 75, your beneficiaries will pay tax at their own personal rate. Pensions can therefore be a useful tool for estate planning.
You can even keep contributing to your pension after you retire. If you have no relevant UK earnings, you can contribute up to £3,600 per year gross (£2,880 net) into your pension. This is especially useful as it allows you to transfer wealth from other assets into the more tax-efficient pension wrapper.
Similarly, you should continue to use your ISA allowance into retirement if you can. Moving assets from investment accounts into an ISA can make your portfolio more tax-efficient over time.
While everyone’s situation is different, as an approximate guide, it is usually optimal to draw on your investments in the following order:
- Cash
- Non tax-advantaged investment accounts (aiming to keep the gains realised within your capital gains tax exemption)
- Investment bonds (up to the 5% per year withdrawal limit)
- ISAs
- Pensions
Diversify your portfolio
Unless you plan to buy an annuity, you will still need to hold some form of investment during your retirement.
Once you have retired your investment objectives will likely change from capital growth to capital preservation. This means that you will probably want to take less risk than someone who is starting to invest for the first time.
You may therefore wish to consider lower risk investments. But there is no such thing as a no-risk investment. Cash does not fluctuate with the market, but at current interest rates is unlikely to hold its value when inflation is taken into account. Property funds can add diversification to your portfolio, but often suffer from liquidity problems when the market falls. Bonds are less volatile than equities, but are still sensitive to market movements.
Equities offer the best chance of beating inflation and growing your portfolio over the long-term, but carry a greater investment risk and their prices can fluctuate on a daily basis.
A combination of asset classes, and a wide variety of different investments, can help to preserve your wealth and manage risk. This might include a modest selection of ‘higher risk’ assets as well as more stable investments.
Keep an eye on your budget
Tax and investment planning only go so far. It’s also important to stick to the plan, as if you overspend, this can limit your options later on.
A cashflow plan is extremely useful when you retire, as it will give you an idea of whether your retirement goals are achievable, or prompt you to rethink your priorities. Despite how helpful cashflow plans can be as a planning tool, they are built on a series of assumptions and therefore will never be entirely accurate.
It is important to regularly review your plan, your budget, and your investments, as it is then easier to make small adjustments and correct your course if need be. A good financial adviser can help you, not only with the technical aspects of investment and retirement planning, but by holding you accountable and keeping you focused.
Please do not hesitate to contact a member of the team to find out more about retirement planning.