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The Biggest Holiday of your Life
Craig Dowsett is an authorised Independent Financial Adviser and Advanced Diploma qualified. He works with both individuals and corporates, advising on their holistic financial planning needs. Prior to working in financial services, Craig played professional rugby; he brings the same drive and determination to his client work. In our Vintage thought leadership series, he has chosen to discuss retirement planning.
Retirement planning is important not only for people operating in financial services, it is important for everyone. If you think about it, when you come to retire or when you stop working, you are beginning the biggest holiday you’re ever going to have.
When you go on holiday with your friends or family, you will book your flights, plan where you’re going to go and what you’re going to do… so, when you’re going on the biggest holiday of your life, why wouldn’t you prepare for it? You need to plan for retirement because otherwise, you could run out of money or not be able to maintain your standard of living.
When going on holiday, you will budget, ‘I’ve got this much to spend each day’. It’s this kind of concept that should be applied to retirement planning but on a bigger scale. It is so important to have a clear picture of what you’re going to do and how you’re going to achieve it.
The State Pension provides minimal benefits for most people; there is a clear need to supplement state retirement provisions with a private pension. For this reason, retirement planning is important for everyone in all walks of life. There are two ends of the retirement planning spectrum; people in my age bracket – I’m 28 – why is it important now to start saving for retirement? This is the building stage, which lays the foundation for your future.
Then at the other end of the spectrum, you have people who are entering retirement and in the decumulation stage of their pension lifecycle. Planning is probably most important in this latter stage.
If I start by looking at the younger generations, we need to get across to people that they must start saving and building a pension from a young age. The pension and savings can then be invested for growth and will set you up for when you actually come to retire.
The money that is saved in the early years into a pension or other savings vehicle has the benefit of compounded growth for the years it is invested.
Let’s say you save £3,600 a year, which is the maximum somebody with no earnings can contribute to a pension. A contribution of £3,600 a year is going to add up over time. If the funds are then invested, by the time you come to retire you could have built up a retirement fund of over £180,000.
As an example, a retirement fund of £180,000 could provide you a 65-year-old with a single-life annuity income of £9,200 a year. When you add this retirement income to the State Pension of approximately £8,767, you would have more than doubled what you can live on in retirement.
Many people put pensions on the backburner. Obviously other things in life come before retirement; the younger generations could be saving for a property as their number one focus. But once the property is purchased, pensions and other savings vehicles shouldn’t be forgotten. If you can save 15% of your salary in some way, as an example, 5% in a pension and 10% in an ISA, you will put yourself in a good position.
Auto-enrolment is now forcing people to save for retirement. The auto-enrolment system was introduced because the government are foreseeing issues that will arise further down the line and want to counteract this, as the State Pension won’t provide enough for people. The State Pension also doesn’t account for longevity. As people are living for longer and trying to stretch money across a much bigger bracket it becomes more important for everybody to save into a private pension.
If you can take a long term view on your savings, things will still change, but at least you’ve put yourself in a position where you hopefully won’t be struggling financially. The key to saving for retirement is to start as early as possible.
The importance of financial planning when you enter retirement is how the funds are drawn.
For many people, as soon as they reach the age of 55 and are entitled to their 25% tax-free lump sum, they will draw it. Why take that 25% tax-free cash out? Just because it is tax-free money. However, it could affect how you control benefits being drawn further down the line.
There are wider issues that should also be considered before making this decision, as an example, the pension falls outside of the estate for inheritance tax purposes. Therefore, the pension could also be a good useful financial planning tool to help your family to avoid inheritance tax. By drawing the tax free cash, you could be making this a taxable benefit for inheritance tax purposes.
One of the most common views that people take when it comes to the underlying investments in a pension is ‘it’s my pension, it needs to be low risk.’ Obviously, attitude to risk will be different for every individual and will depend on personal circumstances.
However, in the early years of holding a pension, people can typically tolerate a higher level of risk in their pension investments. Therefore when you’re younger, you will want your pension to work harder.
Investment timescale is a key factor when establishing what level of risk can be tolerated – when you are in your 20s and you can’t access your pension till age 55, investment timescale is on your side.
At the other end of the retirement lifecycle, when people have already retired, there is a belief that any risk needs to be taken off the table. If you’re going to buy an annuity with the fund, then this might be appropriate as you don’t want to risk a decrease in fund value before you purchase the secured income.
Most people now are using Flexi access drawdown pensions or pensions that can provide flexible benefits. You can effectively view it as a big investment pot and draw money out as and when required. You can blend tax-free cash withdrawals with taxable income allowing you to maximise tax efficiency where possible.
Understanding the full range of retirement options available is extremely important as you enter retirement, and this highlights the need for advice.
At Vintage, we work with clients to ask thought-provoking questions, such as, ‘What’s the planning need?’ ‘What income requirements are you going to have now?’ ‘What’s is your goal and financial need for the next 2-3 years?’
This allows us to establish the best retirement solutions to match individual requirements. Once we have identified the objectives and developed a strategy, a portfolio can be designed to match the client’s attitude to risk and income requirements.
There are changes taking place at the moment because most people are moving away from the annuity market. Retirement income can be underpinned with an annuity but many people can generate sufficient returns from their retirement investments to provide an income without locking away the funds they have built up.
When a secured income isn’t used, then it is extremely important that a clear cash flow model is developed to understand what income levels can be withdrawn and what returns should be targeted to ensure the funds last.
This is probably the biggest current development – making sure that money lasts. It’s also where advice is important because people don’t know about all of the options in retirement. Cash flow modelling is a key tool used in the retirement planning process.
Working with an adviser to build a cash flow plan will help to forecast and identify the levels of income and expenditure you will have in the future.
Once a cash flow forecast has been created, we can then stress test the plan, to check the impact of different market conditions on your retirement provisions.
At Vintage, we take a holistic approach to our client’s financial planning, ensuring we understand a client’s full circumstances. As an example, a client with an objective to look after the beneficiaries of their estate and avoid inheritance tax doesn’t need to draw from their pension.
We may look at drawing funds from other sources first such as their ISA or bond before we then draw on their pension. This is because the pension falls outside of the estate for inheritance tax purposes and can act an effective inheritance tax mitigation tool.
We’re not just picking and choosing; this is why a clear understanding of a client’s circumstances allows us to develop a tailored holistic plan.