How To Avoid Longevity Risk in Retirement (pt 2)

Hello, 

How can you avoid running out of money in retirement? You might remember last month I introduced you to Mike and Helen, our guinea pig retirees.

If you missed it here’s a reminder.

Mike & Helen had a decent pension fund @ £500,000 but were unsure how much they could afford to draw every year without running out of money in retirement.

The problem?

➡️ Without a crystal ball and knowing exactly how long they would live and how well/badly investment markets would perform over the course of their retirement, made planning with certainty almost impossible.

How on earth can you squeeze as much enjoyment and experience from retirement whilst you’re still young, fit and able when at the back of your mind is the niggling question: what if we run out of money?

In last month’s email I delved into Mike and Helen Smith’s financial lives in detail and we looked at how their financial plan stacked up if they were to remain invested solely in cash.

It was unsurprising to learn they had poor chances of achieving the standard of living in retirement that they would hope for.

Put simply: cash doesn’t pay. You need to remain invested in the financial markets even when you transition into and enjoy retirement.

People are retiring earlier than ever before. One thing the pandemic taught us was that we never know what’s around the corner and working endlessly in the pursuit of ‘financial independence’ isn’t always necessary.

I love my job because I get to tell people they are already financially independent and they can afford to retire earlier than they may have hoped.

But how do I do this with confidence when we don’t know what’s around the corner?!

I use modelling and educate clients to continue to trust financial markets will do their thing during their retirement.

The power of having a diversified portfolio that offers chances for good growth in excess of inflation is what gets people to a good financial place ahead of retirement, but that doesn’t mean you need turn off the ignition once you reach retirement.

The terminator of wealth that is inflation doesn’t stop. Market cycles will continue to ebb and flow and unless you remain invested your chances of living a dignified, relaxed and comfortable retirement are severely impaired.

Mike and Helen worked hard to build up a shared pension portfolio of £500,000, which on the face of it appears sizeable, but they perhaps need to question how well will this stack up against the latest indicative retirement living standards?

How can Mike & Helen improve their chances of living a comfortable retirement?

Based on current annuity rates, a comfortable retirement requires a pot worth at least £590k, when accounting for other incomes such as state pensions.

But what if Mike and Helen planned to drawdown their pensions over time?

Remember in our case that:

• Both Mike and Helen are due to receive their full State Pensions at state pension age;

• They don’t plan to gift any money to their 3 children;

• They aren’t concerned about planning for potential care costs and hope these won’t materialise in the future;

• They are happy in their family home and don’t want to ever move as they like where they live and have family and friends around them;

• They pay professional fees of 1.5%, which includes all fees paid to us as their advisers, their platform fees and investment fees. This is what our typical clients would expect to pay, below the standard average 1.9% ongoing fee charged by other financial advisers);

• Their investment portfolio is originally invested solely in cash so they aren’t taking any investment risk whatsoever;

• They hope to spend around £40,000 per year to enjoy a rewarding and enjoyable retirement.

If Mike and Helen continue to withstand a degree of investment risk in retirement then their plan becomes increasingly more achievable.

Even though market crashes will inevitably come (history tells us 1 in every 4 years), applying rigorous testing shows us that they will have a much greater likelihood of enjoying the standard of retirement they would hope for.

Cash is often referred to as ‘risk-free’, but the greatest risk to your financial plans is the risk of low returns.

When we tested a strategy of remaining invested in a globally diversified, low cost equity portfolio against 109 years of rigorous data, their financial assets outlasted them in 71% of all scenarios (compare this to 8% in last month’s email!). 

Expressed another way: 29 times out of 100 they’ll run out of money (whereas last time it was 92!)

Like we did last time … we can look at this another way: Mike and Helen’s income needs of £40,000 per year are much more sustainable than they would be if they sold to cash.

By looking at how their portfolios would have performed historically in different time periods we can see that in around 3/4 of cases they would be able to enjoy £40,000 a year from their pensions. In some years they could have afforded to draw more than £40,000 and closer to £70,000 – win, win!

So what does all this mean?

In the case of Mike and Helen we have learned that investing in markets should continue in retirement.

Retirement doesn’t mean Mike and Helen, or you for that matter should take all risk off the table. When you hope to live for another 30+ years you have a vast investment timeframe ahead of you that you should continue to optimise.

Retirement doesn’t play out in a straight line however.

❓What if Mike and Helen decided to gift some money to their 3 children. How would that impact their picture?

❓Or what if Mike sadly passed away 10 years into retirement. How would his death affect Helen’s financial picture?

You can go on and on with endless iterations and ‘what-if scenarios’, which is why financial advice should never be a one off event.

Life plays out in uncertain ways and the key is to have confidence in your plan and commit with conviction.

There will be inevitable changes to come – I recognise that – but in Mike and Helen’s case, step 1 involved simply reshaping how they consider and think about risks of running out money.

By doing this, we can already see this has yielded positive benefits and has gone a long way to helping them retire with confidence.

Be positive about your wealth.

Know what you have.

Know what you need.

And then make your wealth work around your life.

Money for the sake of money never leads to true happiness.

As always, thanks for reading.

Benjamin

Disclaimer – the above is intended as guidance and should not be relied upon as financial advice. Please seek regulated financial advice.

Benjamin Mitchell

Benjamin Mitchell

I’m a chartered financial planner that can help you plan for tomorrow and also live for today.

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