Fast approaching retirement? You may be wondering how best to manage and drawdown from your pension during the current economic market.
Planning for your retirement is one of the most important things you can do for yourself. Unfortunately, many people fail to properly plan for life after they stop working. For those that do, many underestimate how much they’ll need for their desired lifestyle in retirement.
Of course, everyone has different needs and wants, but in this article we’ll show you some examples of how much you’ll really need to save for your retirement – it might be more than you think.
When it comes to planning for the future, there’s something often overlooked but crucial to making sure you can afford the retirement you want – inflation. Inflation means you won’t be able to buy as much in the future with the same amount of money as today. With current price spikes, however, investors have been reminded not to ignore it.
Although we wouldn’t expect inflation to remain as elevated as it is now, no one knows how high inflation will be in the future. For this article, however, we’ve used an illustrative inflation rate of 3%. That’s not a prediction of future inflation, but the approximate average level of global inflation over the past 20 years.
The table below shows how much more income you could need when you retire to keep pace with inflation. To have the same purchasing power as today if you retire in 10 years (assuming 3% inflation), your income figure will need to be over a third higher. If you’re retiring in 20 years you’ll need an extra 80% and if retirement is 30 years away, you’ll need an income figure nearly 2.5 times higher.
Once you know how much income you want, taking inflation into account, you’ll then need to work out how much capital you’ll need to produce that income. There are two broad considerations here. Do you just want to take your portfolio’s total return (combined income yield and capital growth) leaving your capital intact? Or will you use the capital as well as well as the total return for income, dwindling your capital over time? You’ll get more income from the latter option, but you’ll need to manage this very carefully to avoid running out of money. For now, we’ll assume you just want to take the total return.
The return your portfolio delivers, however, depends on market performance and how much risk you take. In general, taking a more adventurous approach delivers higher returns over the long term but also more variable performance, larger falls, and longer recovery times. That’s why most investors in retirement take a lower-risk approach, giving up higher income yields and growth for greater stability.
The table below shows are range of long-term average returns – 3% for a cautious approach, 5% for balanced and 7% for adventurous. These are illustrative, based broadly on historical returns and not what you’ll actually receive. Remember also these are averages – one year you might get 20% and the next you could lose 10%. That’s why we recommend having a cash buffer. This can supplement your income when markets fall, and can then be topped back up when they rise again.
If you think the sizes of those portfolios look on the high side, you’re not alone. If you consider them unachievable though, you’ll either need to lower your income expectations or, as many prefer, supplement your income with other sources. This could include company and state pensions, rental property, or taking part of your portfolio’s capital.
There are other considerations too. No one knows how long they’ll live and therefore how long they’ll need their income to last. That means you could face ‘longevity risk’ or, in other words, the risk of running out of money before you die. Also don’t forget inflation doesn’t stop once you reach retirement. So if you want to maintain your lifestyle during retirement, you’ll need to safeguard your purchasing power by increasing your income with inflation.
If all this sounds like it’s getting too tricky, that’s sort of the point. Planning for your retirement is incredibly important but can also be very complicated. Fortunately though, help is at hand. Our qualified and regulated advisers can assist you in planning for your future. They can identify any shortfalls in your desired retirement income and help you plan so you can live the retirement you dream of.
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