Introduction
Before we reach retirement, it helps to have a vision of what it might look like. We’re looking at what you need to think about as retirement looms over the horizon. It’s no longer a hazy, one-day possibility – it’s coming up fast, so we need to get serious about what we want it to look like, so we can be ready. Read more about preparing for retirement here.
Yes, retirement is hoving into view, and as such, you’ll be getting a much clearer picture of what it is going to look like. Firstly, I want to go over some things to think about, and then the practicalities of making sure the money meets the vision.
Everything You Need to KNOW
Your Retirement Will Evolve
The danger when talking about retirement is to treat the whole thing as a single event. In fact, it is a very long period of time; for many of us the last third of our life. It is ridiculous to expect every day to be the same across a 30-year timescale. A 30-year retirement will instead be made up of many different, shorter phases.
While there is no average retirement, many of the clients I have known over the years have spent more money in the first five years of retirement than in every subsequent five-year period. This is because they have the time and the resources to make the best use of that time. They tend to have more holidays, change the car and take up new, more expensive hobbies.
Then things tend to settle down and find a groove, and spending does the same. There are always exceptions of course, like one-off expenses for big birthdays or family events like weddings or grandchildren going to university. But for the most part expenditure becomes predictable.
On average, retired people’s expenditure decreases by about a third in real terms between the ages of 65 and 80, according to a study by the International Longevity Centre UK.
All of this means that, most likely, the gap between your income and expenditure will be largest in the early years of your retirement. If you retire before your state pension age, there will be a period where you won't be receiving all of the secured income that you will eventually have, so the draw on your capital will be greater in the early years.
Cashflow is Everything
This is a good time to remind ourselves that cashflow really is everything. No matter how wealthy we may be, we all tend to judge our financial health by the amount of income we have coming in. If this is less than we are spending, then we know we are getting poorer.
When planning for retirement our starting point needs to be secured income. Secured income is income which is guaranteed and likely to rise. So your state pension would fall into this category, as would benefits from defined benefit pension schemes. If you have an annuity, this would be secured income.
If you have a rental property, you could argue that this is secured in that you have an asset which produces an income, but it certainly isn't guaranteed and it is likely to be variable if you suffer blank periods or have high maintenance costs. Remember that you may well continue to earn an income in ‘retirement’ by doing some part-time work or odd jobs or whatever – this would be secured income.
Once we know what our secured income is likely to be, we can identify the gap between that and our expenditure – more on this in a minute. That gap will need to be filled by drawing from capital and if we draw too heavily, then capital will be eroded over time. It is important then to have a clear picture of our expenditure.
The Crucial Distinction Between Required Minimum Expenditure and Desired Lifestyle
Of course, there is expenditure and expenditure! We should distinguish between expenditure which is mandatory and that which is discretionary. I tend to use the words ‘required’ and ‘desired’ to distinguish between these.
Required expenditure is what you need to spend to keep the lights on and food in the fridge. It should also include any travel costs to and from the supermarket, your local town or to visit family. Insurances for the home and any life insurances also fall into this category.
Then there is a kind of grey area where things which one person may consider a luxury are in fact a necessity for you. This might be a golf club membership if you've been a lifelong golfer. Or if you love your box sets then Netflix might be considered a mandatory cost.
For now, it is just important to understand the distinction between the two. Consider your required expenditure a minimum lifestyle cost without too many bells and whistles and luxuries.
So, now you know why you need to refine your retirement vision, let's dig a little deeper into that.
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