Retirement Income

For many people, the second stage of the financial timeline is the Retirement Income phase - the time to enjoy the fruits of your labour. In this stage, most people are planning their retirement income so they can have enough money to do the things they want while still coping with inflation and paying as little income tax as possible.

This stage requires a strategy that allows you to generate your desired retirement income from different sources, such as your ISA or other investments, and make the most effective use of your pension entitlements.

When it comes to retirement income planning, there is no perfect method or simple solution. Every individual's situation is different and everyone will have a different investment strategy for the best way to generate their desired income in retirement.

In retirement, you will have a combination of different income sources that need to be integrated. You will probably be entitled to some type of government benefit like the state pension. You might have a company pension plan, or you may have your own personal savings such as a Stakeholder Pension or SIPP (Self Invested Personal Pension). Or you may have other investment sources such as shares or property.

When creating an investment strategy, we determine the income you will need to maintain your standard of living. First, we prepare a retirement income projection to illustrate the growth of an investment portfolio over a number of years. We also use projections to estimate the income that can be generated by a given portfolio during retirement. Then we determine how your different income sources can be integrated in the most effective manner to generate income (after-tax, after-inflation) in your retirement years.

When heading into retirement, you want your investment portfolio to be as tax efficient as possible. Taxes on distributions can reduce the return on an investment, so we organise your portfolio to minimise the amount of taxes being paid.

We use our disciplined process to determine what strategies will best suit your financial concerns, goals and objectives. Following our guiding principles, we use a comprehensive planning approach to create a financial plan that best suits your unique situation

Retirement income planning is a process, not a one-time event. To manage it effectively, you need a strategy or game plan that can adapt to changing market conditions as well as to personal needs, goals and objectives- any of which may change dramatically over time.

Determine Income Needed to Maintain Standard of Living

This step involves taking your financial objectives and putting numbers beside them.

First, working together, we build a list of your primary expenses - the things you absolutely need to spend money on. Then, we create a list of those secondary expenses (or objectives) that aren't essential but would enhance your happiness, such as travel, hobbies and gifting.

Using state of the art investment psychology profiling software and good old-fashioned face to face conversation we develop an Investment Policy Statement (IPS) that captures your unique goals and objectives along with your risk tolerance. Typically, this is a detailed document that sets out exactly how your account should be managed given your personal constraints.

When estimating your life expectancy, add at least 5 or 10 years to your number. This is because life expectancy is a median number, that is, half the people of every given age die before this date and half the people die after this date. This personalised retirement illustration should be rerun every few years as assumptions will change and your lifestyle wishes may also vary over time.

Finally, we design a tailor-made financial timeline and investment strategy that will allow you to generate an income through your retirement years. In generating an income during retirement, it is often important to not withdraw funds from an asset class that is declining in value. If you are unlucky enough to retire when the stock market is performing poorly (and you need to generate income from your portfolio), then you could deplete your capital at an alarming rate - and reduce the chances that your portfolio will be able to generate your required net spendable income throughout your remaining retirement years.

Prepare Retirement Income Projection

There are many variables and assumptions that go into a financial projection, such as rates of return, portfolio contribution amounts, inflation, tax rates, income needs at retirement, life expectancy and sources of other income (pensions, etc.).

We use projection software that will factor in all of the above variables (and many more) to provide a complete picture as to how feasible your retirement income plan actually is. Please understand, however, that financial projections can be quite different from your financial reality at retirement. The further you are from retirement, the more sensitive you must be to the various assumptions used in financial projections. Even a slight variation in assumptions can have a dramatic impact on your retirement picture.

Income Integration

In retirement, you will have a combination of different income sources that need to be integrated. You will probably be entitled to some type of government benefit you may have a company pension plan and you may have your own investment assets. It is important that you use these income sources in the most effective manner to generate your desired net spendable (after-tax, after-inflation) income in your retirement years.

Financial security in retirement is about understanding, accepting and managing the risks associated with generating a desired level of retirement income.

Retirement Income Risks

When projecting for retirement income, we take into account major risks that retirees face in terms of protecting their assets. Here are a few:

Loss of Capital (or Stock Market Risk)

When you are working and accumulating retirement savings over a long period of time, stock market volatility is not a huge concern as long as your portfolio is properly diversified. In fact, volatility will likely increase your return if you are investing a fixed amount of a particular investment on a monthly basis.

One of the greatest risks in retirement income planning, however, is having the stock market drop substantially just before or just after you retire, forcing withdrawals (for income) from your investment assets once they have declined in value. You need to implement an investment and income strategy that will allow you to deal with extreme market volatility.

If you are unlucky enough to retire when the stock market is performing poorly and you need to generate income from your portfolio, then you could deplete your capital at an alarming rate. Ultimately, this will reduce the chances of your portfolio being able to generate your required net spendable income throughout your remaining retirement years.

It is important to develop an investment strategy that deals with the volatility and short-term fluctuations in the market.

Longevity Risk (Life Expectancy)

Life expectancy is one of the most misunderstood aspects of retirement income planning, yet it is one of the most important factors. Most people assume that life expectancy is the same as lifespan. This is not correct. Instead, life expectancy is a median number of years. In other words, 50% of a particular age group will die before this number of years and the other 50% will die after this period.

A couple who are 65 years of age each has a life expectancy of approximately 26 years. In this example, a couple aged 65 has a 30% chance that one of them will live beyond their 95th birthday.

For example, a male who is 65 years of age today has a life expectancy of 19 years; this means that he is expected to live until age 84. There is, however, a 50% chance that he will live longer than 19 years. A female who is 65 years of age today is expected to live for another 21.5 years (age 86.5). But, she has a 50% chance of living longer than 21.5 years, and a 41% chance that she will see her 90th birthday.

The result for a couple both age 65 becomes quite interesting. In this case, there is a 58% chance that one of the two will survive to see his or her 90th birthday.

Inflation Risk

The inflation rate is usually measured by the year-over-year change in the Consumer Price Index (CPI). It measures how much a basket of commonly purchased goods and services increases in price over time. There is a high probability that your retirement could last over 30 years. Therefore, it is important to understand how the inflation rate can affect your ability to maintain your desired lifestyle. The following chart demonstrates that if you would like an income of £50,000 per year during retirement, you will need to spend more every year to maintain that standard of living. For example, if the inflation rate was 4% (a very approximate historical long-term average), you would need an income of £109,556 in 20 years to buy the same basket of goods which you could buy today for £50,000.

Inflation rate	10 years	20 years	30 years
2%	60,950	74,297	90,568
3%	67,196	90,306	121,363
4%	74,012	109,556	162,170
5%	84,445	132,665	216,097

How Much is Enough?

Do you have enough income? This is a very difficult question. There is a general principle that states you will need 60% to 70% of your income immediately preceding retirement in order to maintain your standard of living during retirement. The rationale behind this rule of thumb is that in retirement you are no longer saving and you would no longer have employment-related expenses and most likely, no mortgage to pay or children to support (although for many people, the 'Bank of Mum and Dad' stays open way after the children leave home!).

This number will be different for everyone. It depends on what you intend to do with your life in retirement; this will drive your particular income requirements.

Finally, remember Health Care Costs

As the baby boomer generation retires, the healthcare system will be under increasing strain. There may be substantial changes to the system, or you may lose the ability to live independently and need a caregiver. Whatever the case, it is very possible that you may have to spend a substantial portion of your retirement income on health care costs. It is very difficult to predict how much of your additional savings you should allocate to health care, but it would be imprudent to ignore this potential problem.