For many of our clients the key financial aspect to a fulfilling retirement is the confidence of knowing they will not run out of money.
Annuities were previously a staple of income for those reaching retirement with defined contribution pensions. In the past decade however annuity rates have plummeted largely due to increased longevity and interest rate cuts.
In years gone by the transition to retirement used to be relatively straightforward: annuity rates were healthy and income drawdown withdrawals were restricted by Government Actuary Dept. (GAD) rules. This meant that overspending in retirement using money within a pension was unlikely.
The pension freedoms of 2015 and the factors mentioned above have prompted a major change in the way we now access our retirement pots. One example of this is the fall in use of annuities and the upswing in use of income drawdown arrangements.
Pension income drawdown is a way of using your pension pot to provide you with a regular retirement income, usually by investing for this purpose. The income you get can vary depending on the fund’s performance. It isn’t guaranteed for life.
One attraction to drawdown is the greater flexibility and control it gives an individual over their pension funds. The downside to this is that with greater control comes greater complexity – and risks, for those who rely on their pension income throughout retirement. With this in mind I consider below some of the challenges facing retirees in 2019.
Longevity risk refers to the risk of outliving your savings. Longevity issues arise as people enter retirement, generally with a fixed amount of money to fund their retirement years but with no idea of how long they will live and, therefore, no idea how long their money needs to last.
Inflation risk is the threat of rising prices eroding the buying power of your money. Investing is often seen as the best ‘hedge’ against inflation. Taking additional risk with your pension funds can potentially provide returns that outstrip the rising cost of goods and services. However, taking on this additional risk means a greater chance of losing money.
Investment risk describes the uncertainty of the returns you may receive on an investment. It is an indicator of the potential for losing money and making money. Over the long term investments that have higher risk usually have higher rates of return.
Taking regular withdrawals in times of market stress can destroy the health of your pension pot, causing you to run out of money much sooner than you might have planned.
Sequencing risk relates to the sequence in which portfolio returns are generated i.e. weak or strong years for performance, and in which withdrawals are made from the pension. If returns are weak and a high level of income is withdrawn, this can affect the long-term value of the portfolio and its ability to meet future withdrawal requirements. It affects investors who are relying on their portfolios for an income, which is what many drawdown investors are doing.
Taking the above together some naturally feel apprehensive making decisions that will affect the rest of their life.
Financial Planning helps you to understand if your current and future financial position will allow your goals for a full retirement to be achieved and, if they are not likely to be, what actions you need to take to help make them achievable.
Barra Gorman APFS
Chartered Financial Planner