Sustaining pension income in retirement is a common concern for most of us. We work hard to build up our pension pots in the hope that come the glorious day of retirement we can sit back and enjoy the fruits of our labour. However, for those in Defined Contribution (DC) plans it’s still important to monitor and manage the underlying investments to make sure that income is maintained and sustainable.
Pension freedoms legislation was introduced in the UK in 2015. These freedoms allow savers to access their DC pension benefits in whichever way they prefer. For UK tax payers, 25% can be withdrawn tax free, with the other 75% being subject to normal income tax. Non-UK tax payers need to be careful in this instance, as any withdrawals made will be subject to local taxation, which may not be as generous as in the UK.
Some countries don’t allow any form of lump sum withdrawals, which means that all withdrawals are subject to tax. Others, such as France, allow lump sum withdrawals, but they are subject to tax, and the inevitable social charges!
HMRC published figures showing that £21.7bn has been withdrawn under pension freedoms rules since introduction. Around £2bn was withdrawn by over 250,000 investors in the 3rd quarter of 2018 alone.
Making ends meet
Stock markets have risen over the last 10 years; most people’s pension pots will have grown steadily and income will have been sustainable. But, what happens if/when markets correct, and what can we do to minimise disruption to our financial planning?
Here are 8 issues to consider for sustaining pension income in retirement:
The 4% safe withdrawal rate (SWR)
Around 20 years ago a US financial planner called Bill Bengen back-tested investment portfolios from 1929 in order to calculate what rate of withdrawal can be sustained over various time periods, including inflation adjustments.
His analysis concluded that if someone sticks to a 4% annual withdrawal rate, income has a 95% chance of being sustained for at least 30 years. Other studies have shown that by sticking to the 4% SWR, not only would you be successful in sustaining pension income in retirement, but capital will also most likely grow. This would give pensioners ‘peace of mind’ and may even let them pass on wealth to the next generation.
Retain a high cash balance
There are pros and cons to retaining a high cash balance. The most obvious disadvantage of holding a large cash element in a portfolio is the risk of not participating in stock market growth as and when it occurs. The argument for holding a high percentage of cash is that when corrections do happen, income can be taken from this part of a portfolio, allowing the full value of invested funds to recover over time.
Income producing funds pay a dividend each year, based on a percentage of the underlying capital value of the fund. Well managed funds are able to sustain the level of income distributed whilst keeping the capital value steady and rising over the longer-term. Investing in income funds that don’t dip into the capital is thus a good way of sustaining pension income in retirement. When markets do fall, income may reduce, although this should return to previous levels as markets recover.
Consider other sources of income
If income levels from income generating funds drop, it might be a good time to consider using other sources of capital for cash purposes. Income from ISAs is tax free in the UK; bank deposits are another source of ready available cash. By turning the drawdown tap off for a while, the pension investment portfolio will have time to recover; short-term pots can be refilled at a later date.
Pension freedoms allow savers to adjust and manage their income requirements. You should consider carefully how much income is taken from pension plans every year, as well as the tax implications of doing so. Tax rates and liability change; there is no point paying extra tax when a different approach might create a lower liability. For international investors who live in Spain or France, investment products exist which enable significant tax benefits for those who wish to use them for income withdrawals.
If all the above options have been exhausted, it may be a good time to consider a reduction in spending. This might not be a desirable option, but it may be necessary if we want our pension pots to survive for our whole lifetime.
Sustaining pension income in retirement: Take advice
The modern-day financial adviser is highly qualified and ready to help. The importance of cash-flow modelling is fundamental to accurate and quality retirement advice. There is nothing especially mysterious about this as it is essentially just a mathematical exercise. An effective cash-flow model should take account of as many variants as possible, including differing levels of portfolio growth, charges, regular and one-off expenses. Once your personal model has been created, it’s easy to adjust and amend in accordance to changes in your circumstances over time.
Lastly, you should ensure that you have online access to your pension portfolio so that you are able to make adjustments easily and quickly. Most pension providers have online capability; however, they do tend to vary in terms of the level of service on offer to clients. You should include online access as a requirement when deciding which provider to invest with.