Make sure your money doesn’t run out in retirement

Planning for a comfortable retirement is difficult. Low stock market returns, interest rates at 0.5% for the foreseeable future and inflation eroding your savings means there is little margin for error. In our experience, you need to consider the three key elements: –

1. How much money will you have when you retire?
Look at your current position and future earning power. Your savings should include equities, pension pots and insurance policies. Calculate how much you might be able to save for the remainder of your working life.

2. How long will your investment portfolio need to provide for you?
People are continuing to live longer and your retirement plans should take account that you are likely to live well into your eighties. Today, a 65 year old man can expect to live another 18 years while a 65 year woman is likely to live another 20.6 years (Source ONS)

3. How much income do you need each year and how much would you like to leave to your family?
What will be your annual income requirement during retirement? This will indicate how much you will have to save before retirement? If you wish to leave a lump sum to your family, the amount you can draw down each year will be reduced.

How much do you need to save to avoid the risk of running out during your retirement?
The sum of money you need to save will be a function of your annual income requirement once retired, your acceptable level of investment risk, your life expectancy, and how much you wish to leave your children.

The table below shows the probability of you NOT running out of money over a set number of years across three portfolios with different risk profiles. For example, if you have 90% of your portfolio in real assets, such as equities, property and commodities and live for another 30 years with a 10% annual drawdown, there is only a 44% chance that you have will have enough money so see you through your retired years. However, if you have only 50% in these riskier real assets, live another 30 years but only take an annual income drawdown of 4%, your investments have a 90% chance of being adequate.

Example
A woman retiring at 55 in 2012 with a total portfolio of £500,000 can have an annual income, which keeps pace with inflation, of £20,000 with a 90% chance or greater of her investments outlasting her.

Table: Probability of NOT running out of money during your retirement

Annual Income Drawdown Life
Expectancy
50% of portfolio
in real assets*
70% of portfolio
in real assets*
90% of portfolio
in real assets*

10% Income 10 Years 72% 75% 77%
Drawdown** 20 Years 44% 51% 56%
30 Years 28% 37% 44%

4% Income 10 Years 98% 98% 98%
Drawdown** 20 Years 94% 95% 95%
30 Years 90% 92% 93%


Source: Cormorant Capital Strategies 2012
Table notes:-
*Real assets or growth assets are the riskier asset classes i.e. equities, property and commodities, which are likely to keep pace with inflation. The remainder of the portfolio is held in safer, less volatile bond investments, which are used to diversify risk.


** The initial income drawdown increases by inflation each year which is assumed to be 3% per annum

Our calculations should be seen as nothing more than approximations and it should be noted that past performance is not a reliable guide to the future. We use a statistical simulation method known as Stochastic Present Value of Spending (see, for example, Milevsky and Robinson 2005). This method harnesses a large number of underlying assumptions including estimates for portfolio returns and risk, retiree lifespan and inflation. We also assume a constant level of real annual income. All values are expressed in today’s pounds (£). Tower Hill Associates does not guarantee the performance of their portfolios and the price of funds within in them may go up or down and the investor may not get back the amount invested.

If you have any questions on this article or require financial planning and retirement planning advice, please call 020 3865 2379.

 

 

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