Soaring government debt and the fact that people are living longer may force the state pension age to rise by at least another five years to a minimum of 70, a leading think tank said this past week.
Many people’s plans for the ”holiday of a lifetime” will be delayed – perhaps indefinitely – if the National Institute for Economic and Social Research is right about state pensions. But individuals who are willing to plan ahead – and save adequately to fund those plans – can still enjoy happy times after work.
They must be realistic, however, because – despite last month’s stock market rise – most pension fund values have fallen in recent years; and so have annuity yields. Here are 10 basic pre-retirement steps to help you make an informed decision about your plans.
1 Review your expenditure
You should start with your current outgoings and then revise this to take account of items that will change after retirement. You may, for example, have to replace a company car with your own – but you will save on commuting.
2 Make a list
Detail all your financial assets – not just pension funds – which have the potential to generate a future income, even if they are not doing so at present. That will allow you to calculate the maximum possible income that could be available.
3 Think about the real return
The results of points (1) and (2) above will determine whether you can afford to retire now and/or in what degree of comfort. One critical factor that needs to be accounted for now is the potential effect of inflation. While none of us knows what might happen to the rate of inflation, one sensible approach is to focus on the difference between the inflation rate and investment returns. It is that margin that is ultimately of greater importance than the headline rates on either side of the equation. For example, an inflation rate of 3pc per annum and an investment return of 5pc provides a real return – that is, in excess of inflation – of 2 per cent.
4 What is your attitude to risk?
This may change once you cease to enjoy a salary and are reliant on invested capital to produce income. This, in turn, may lead to a change in some of the investments held in your portfolio to reflect the most suitable asset allocation for your revised circumstances.
5 Can you defer your retirement?
While there are those who effectively have to retire at 65, there are others who have some flexibility over the timing. If the above process reveals that money is tighter than you would like, then perhaps it would be sensible to defer retirement until financial markets improve.
6 Should you buy an annuity?
Annuity rates have dropped recently so if you do not have to buy one just yet, it might be worth waiting for rates to improve. However, you must beware the risk that yields could fall further.
7 Are your assets in cash?
If you are thinking about retiring soon, then it is imperative you move your assets into cash, or near cash, before your retirement date. In the present climate, with annuity rates low and equities having fallen in value it makes sense to be in cash to protect the fund from further possible falls in value while you consider an annuity purchase.
Alternatively, if you have a fund of £250,000 or more and are considering an unsecured pension, otherwise known as income drawdown, then having a portion of the fund in cash to fund the first couple of years’ income payments is sensible.
Deferring annuity purchase and covering the income requirements with cash from your fund could mean by the time you look again at an annuity, equities will have recovered – boosting the potential value of your retirement fund – and annuity rates may also have improved. It is important, however, to beware the risk that share prices and, as mentioned earlier, annuity yields could fall further.
8 Cut your coat according to your cloth
In the current environment, it might make sense to consider not taking that expensive holiday or buying that sports car when you retire. Market conditions might dictate that instead of using a tax-free lump sum to fund a luxury purchase, you consider using it for more practical purposes such as covering living expenses.
9 Are you aged between 50 and 54?
It is worth remembering that from April next year, the earliest age at which we can access our pensions will jump from its current level of 50 to 55. It means anyone now aged between 50 and 54 has the option to take benefits immediately. However, from April 6 2010, you will have to wait until your 55th birthday.
10 Make provision for living longer
Improved longevity needs to be considered. According to the Office of National Statistics, (even allowing for the rise in state pension age for women to 65 being phased in between 2010 and 2020), the proportion of the population over state pension age is projected to rise to 23pc in 2031 – it was 16pc in 1971. Even though our activities and expenditure decrease with age, income will still need to cover the cost of living longer.
These steps should help you to decide if the financial goals and time frame you previously set yourself remain achievable in the present economic conditions. If you do need to replan then it’s important to take action sooner rather than later and to avoid leaving things to chance.