It’s session number 14 , and we’re going to be talking about choices at retirement. Last time we did an overview of pensions before retirement and concluded that they were basically just tax-efficient savings plans for the most part. We looked at the different types in summary, but I said that if you’re further than 10 years away from retirement, you might as well forget about your income in retirement, what form it will take and even how much it might be, and just concentrate on getting as much into your pensions as possible.

This time, I’m going to the other end of the pensions timeline, and look at what choices you have for taking benefits out of your pension plans.

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iTunes Reviews

I’ve had two more 5* reviews this week, the first is from Spybak. He titles his review ‘Thorough and focused’ – I like…

“Literally contains everything you need to know and everything you need to do to manage your money in the best possible way. This podcast is perfect for those who want to learn the basics of money management. It gives you the confidence to take more control over your financial future with advice that is always sensible and grounded. Please keep going!”

Thank you Spybak! I intend to keep going. I feel like I’m really building momentum now I’m going weekly and it’s encouragement like that that will keep me going. It’s great to know that people are listening and getting useful information.

The second review is from Hodge478, who titles his review “Finance for Dummies”

“For somebody who is a novice in all matters financial, but would like to start looking to the future and making the most of what they have, this is a brilliant resource. Succinct and personable host talking you through the world of finance in a methodical and clear way, subject by subject is a great way to learn. Pete also very helpfully signposts other tools and resources that would help those, who like me, are fairly clueless as to where to start. This is one of those little gems that needs to be exploited”

Thank you Hodge 478 for your kind words, I really appreciate it. Getting reviews like this gets me so fired up; it awesome! Do let me know if there’s anything specific you want me to cover. I’ll tell you how to get in touch later in the show.

If you’d be kind enough to leave me a review on iTunes I’d really appreciate it. Here's the link: meaningfulmoney.tv/iTunes

Session Introduction

OK, so you’re 10 years from retirement, and by now your mind is thinking about the longest holiday of your life – retirement. You’re thinking: What will I do with my time? Will I have enough money to do what I want to do when my paycheck stops? You’re going to need to do some planning.

As I said last week, retirement is nothing to do with not working, at least not for the purposes of today’s session. Retirement is taking benefits from your pension plans; taking money out instead of putting it in.

Before we get into specific choices, I must say this, as I do every week, and in most of my videos too: This is a great time to seek advice from a financial planner, and to engage in a process called cashflow modelling. This is a mathematical simulation of your future by taking your current position and projecting it forward. It’s educated guessing of course, but will be really helpful in helping you to visualise your future.

With 10 years or less to go, you may find that your retirement doesn’t look like you thought it was going to. Or you may find out that you can afford to retire early. Without some detailed planning though, you’ll be flying blind. It’ll be time and money well spent.

If you’re determined to go it alone, you’ll need to listen on, but I’ll only be covering things in outline. Whatever you do, don’t make any decision based on what I say in this podcast or in my videos. Every person’s circumstances are different. The choices you make in the run-up to, and at retirement are life-altering decisions. Don’t take them lightly.

Right, rant over. Let’s get to it…

Everything you need to KNOW

1 – It’s all about income and outgoings

All financial planning comes down to this. Your future is all about whether your income covers your outgoings, and whether it will do so for the rest of your life. If so, you’re golden. If not, you’re going to erode your capital.

Think about it. If you have £20,000 per year income, but spend £25,000 per year, you’re going to have to find that £5,000 extra from somewhere. If you have £50,000 in savings, it’s only going to last 10 years. And that’s without taking any account of inflation or investment growth.

If you only spend £15,000 per year, you’re going to be adding to your savings by £5,000 per year instead. The difference is prosperity or poverty.

Seriously, it’s all about living within your means. If you can live the life you want to live, and do so within your means, congratulations, you have made it. If not, you’re going to have to make some changes, both now and in the future.

What these changes are and the extent of them can be identified by seeing a financial planner. But you can also work this out yourself pretty easily. I’ll give you the sums in the what you need to do section a little later

2 – How pension income works – Annuity

You have various choices to make about how your pensions funds begin to pay you an income. Your state pensions will kick in, assuming you have paid enough national insurance. If you have final salary (defined benefit) company pensions, your choices are limited with these, but it doesn’t matter because the benefits are excellent.

With personal pensions or SIPPs, you will have a fund built up, and you have to decide what form the income from them will take. Really important – you don’t have to take an income from the same companies you saved with. This is called the Open Market Option and is vastly underused. We have increased clients’ income significantly just by shopping around for them.

Before you choose how your income looks, you have to decide whether or not to take your tax free cash lump sum. More properly called the Pension Commencement Lump Sum, it is optional. PCLS is usually 25% of the pension fund, but it can be more. Most people do take it, but it depends on circumstances. I had one client who already had £3/4 million in the bank – he didn’t need the extra £50k from his pension!

When buying an annuity, you hand over your pension fund in return for an income for life. This is irreversible, and once you have made your choices, you’re stuck with them. What choices:

• Level or indexed – indexed sounds great, but starts one third lower. In the long run though, this is usually the best option. Most people’s logic is that they will have more now while they can enjoy it. Takes about 18 years at 3% indexed to get the same out as a level annuity
• Spouse’s pension – what happens to your income if you die first?
• Guarantee period – more usefully called a minimum payment period. E.g. If you have a ten year guarantee, and you die after five years, the pension continues paying into your estate for the balance of the ten years. It’s a way of making sure you get at least so much value back from your pension, even if you die early. Less relevant for joint annuities.
• Payment frequency – monthly, annually or some other frequency

There are some variations to standard lifetime annuities:

• Fixed term annuities
• Investment-backed annuities
• Impaired Life annuities – really important if you or your spouse are in poor health. Because your life expectancy is impaired, you may be able to get more income. We had a client recently diagnosed with Leukaemia, and we were able to double his pension income simply by shopping around and seekign enhanced terms.

Annuity choice is complicated! With it, you take the ultimate risk – how long are you going to live? If you live a long time and get 40 years of income from the annuity company, you have won. If you die early, you have handed over that money you spent your life building up, and the insurance company wins.

3 – How pension income works – Income Drawdown

More properly called Unsecured Pension, this enables you to keep your fund instead of handing it over to an insurance company. This is a big deal, because you are taking more of the longevity risk into your own hands.

It remains invested, so it has risks to it – you fund can go up and down in value. Also, the costs of the investment and the running of the plan need to be borne in mind. Annuities have no explicit costs; instead the costs of the annuity company are covered in the annuity rate offered.

Drawdown is like going to your own cash machine every month and drawing your own money out of your fund. It is still income though, and you pay tax on that income just like an annuity.

The amount you can draw as income is generally a bit higher than you would get under an annuity, though it may not be if you qualify for an impaired life annuity if you are ill. The government sets a standard limit for men and women of every age. This is called the GAD limit, named after the Government Actuary’s Department that sets it. In drawdown you can take an income of 120% of that limit.

The GAD limit is expressed as a percentage. So for a male age 65, the current GAD rate is £55 per year of income for every £1000 of fund, or to put it another way, 5.5%. So a man with £100,000 fund would get an income of £5,500 per year gross – before tax. But he can take 120% of that limit, which is £6,600 per year gross

Here's a link to a GAD limit calculator which makes it easy to work out what pension you would get based on the fund size and your age and gender.

4 – You don’t have to approach retirement as a once for all decision

For many people and for many advisers, it’s too easy to get to the point at which you want to retire and take benefits from pensions, and do it all in one hit, but this doesn’t have to be the case.

You can stage your retirement in phases. How about dropping a couple of days a week at work and taking benefits form one of your pensions to make up the income? You get to work less and maintain the income, maybe. Or you can keep working when your state pension kicks in and enjoy the extra income to take a couple extra holidays.

If you have a large fund, you can arrange something called phased retirement, where instead of vesting all your pension funds in one go, you can do a year at a time. Without going into the mechanics of this, it makes for a very tax-efficient income for the first few years.

Taking benefits from a pension is best approached thoughtfully.

So, to summarise:

#1 – It’s about income and outgoings

#2 – How annuities work

#3 – How drawdown works

#4 – Retirement can be done in stages

Everything you need to DO 

So let's deal with everything you need to DO

1 – Work out an approximate cashflow – what does your income in retirement look like?

Working out your retirement income is fairly simple maths:

• Add together your likely income in retirement from all sources:

• • state pensions – You can use form BR19 [LINK] to get a forecast of what your state pensions might be – private pensions,
  • company pensions – Get projections from the scheme.
  • personal pensions – Add up your fund value. Make an assumption for growth over the time between now and retirement and also an assumption for inflation. So if growth is assumed at 5% and inflation at 3%, you’ll need to increase the value of your pensions fund by 2% compound each year between now and retirement. Don’t forget to add in any contributions you’re making. When you get the value of your fund at retirement, use the drawdown calculator to work out what your income might be. Because you allowed for inflation in the growth, this will be in today’s money terms.

This is very rough, and only an estimate, your fund may not perform as well as you expect. Maybe use different growth rates to see what the range of possible returns might be.

Also, note if these income sources are indexed – will they go up each year in line with inflation or a fixed percentage?

• Work out what your outgoings are going to be

Base it on your current outgoings. Then add 20% – you’ll have to find something to do to fill that extra time! In my experience people spend more than they were intending to in the first few years of retirement. Be realistic and brutally honest with yourself. Remember that inflation is a huge factor. Your expenses will go up every year.

• Take one from the other

If you have income left after taking out your expenses, then you’re probably home and dry. But is this still true 10 years into retirement? If your income stays the same but expenses go up, the first few years might be OK, but things can quickly turn downward.

2 -If you get a shock – decide what you’re going to do about it

Say you do the sum above and find out you’re going to be living on £3 a week from the day you retire. I exaggerate (maybe!), but seriously, if you’re not going to be as well off as you think, what are your options?

• Save more
• Invest more aggressively; there’s a link between risk and reward
• Put back your retirement date
• Scale-down your expectations.

 3 – Get a plan

This is where an adviser can help you, not only in setting out all of this stuff for you, but in holding you to account for achieving your goals.

If you know you need to save £500 a month to have the retirement you want and deserve, do you have the willpower to keep going when Apple release their latest device and the money could be diverted there instead?!

For most people, their circumstances will make the planning easy, but there are many who have much more complex existing plans than those described above. Pensions have morphed over the last 60 years so that there are many different kinds of scheme, all with their own idiosyncracies. Understanding them is a specialism, and a competent adviser will not only be able to help you plan, but will help you stick to the plan too.

4 – Start now

The power of compounding is on your side when saving for the long term:

£200 per month put away for 20 years at 5% will give a fund of £82,518

£200 per month put away for 30 years at 5% will give a fund of £167,082

£200 per month put away for 40 years at 5% will give a fund of £306,359

The longer you save for, the earlier you start, the better your future will be. But don’t despair if you feel like you have left it late. There is still hope, but only if you start now!

Summary

I’m aware that some of this might have come across as a little bit of a preach. That was not my intention – I know how difficult it can be to find money in the budget to save every month. But if you managed to get through the exercise of working out what your income might be, I imagine that will have been quite sobering for many of you.

Unfortunately, the days of ‘the firm' looking after you for the rest of your life, after you have worked for them for 40 years, have long gone. Remember though that retirement is changing. We no longer expect to sit around doing nothing. We expect to live quite a long time and be able to use that time to the full. Many people even embark on a new career in ‘retirement’. I’ve heard some American advisers calling it re-tyring, in other words, starting down a new path.

So you may well be able to earn a living doing something completely different in retirement. One thing is for sure though – money gives you freedom. How much better to only work because you want to, not because you have to.

Whether that applies to you, is up to you.

Outro

That's it for this session of the MM podcast, I hope that was helpful. Even though this was the longest session yet, there's still no way I covered everything.

Any questions? Please leave any comments or questions in the comments section below.

If you want me to help you with your reitrement planning, click Work with Pete. This would have to be via my regulated financial planning practice, called Jacksons Wealth Management. even if you're nowhere near Penzance, I can usually advise via Skype

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Next time we'll be talking about inflation, and the impact it has on all aspects of your finances. If you have any questions about this, go to click the green widget on the far right of the site and leave a voicemail

Thanks for listening – I'll talk to you next time