Avoiding the risks of decumulation

As the cost-of-living crisis endures and a recession gains steam, 2023 could be a difficult year for retirement income and portfolios. What can savers do to navigate the risks of decumulation?

As the cost-of-living crisis endures and a recession gains steam, 2023 could be a difficult year for retirement income and portfolios. What can savers do to navigate the risks of decumulation?

While the word was carefully omitted from prime minister Rishi Sunak and his chancellor Jeremy Hunt's Autumn Statement in November, a return to austerity is more than evident in the public spending cuts they say are needed to stabilise the economy following disruptions during the Covid pandemic and Russia’s war in Ukraine. That it comes at a time when the Bank of England says the UK is already in a recession which is likely to last until 2024 is causing concern among many investors and pensioners, who are bracing for a period of decumulation.

Decumulation is a normal feature of retirement. You spend your life accumulating savings which you are then able to live from when you stop working. Naturally, as you draw income from those savings, your retirement pot will deplete from what it would have been had you left it to accumulate further. However, during periods of market volatility and rising costs, the effects of decumulation can accelerate, which could force retirees to have to adapt their retirement plan.

In this instance, there are several additional drivers of decumulation for retirees to contend with. Chief among them is the biggest cost-of-living squeeze in 40 years, which has been fuelled by exorbitant energy bills and a double-digit spike in inflation. To deal with the substantial increase in normal day-to-day lifestyle costs, many pensioners have needed to drawdown extra income.

“There are millions of retirees who did all the right things. They saved and accumulated wealth through their working life. They did some cash flow forecasting with a financial adviser, looked at the valuation of their available assets and thought, ‘I’m set for a comfortable retirement,’” says Mark Rodgers, Independent Financial Adviser at Ascot Lloyd. “Then through no fault of their own we get this big spike in inflation and all of a sudden those cash flow forecasts go out the window and your income and available assets are no longer sufficient for your desired lifestyle.

“Therefore you have to start spending that wealth as capital as opposed to generating income, which does two things: it reduces the value of your assets and, because they’re then worth less, it reduces the income those assets will produce now and in the future. It can be a vicious spiral downwards when you start doing that, but many people have felt left with little choice.”

Volatile markets

The volatility of equity and gilt markets this year has added further risk of decumulation. We all know investments can go down and as well as up, and it has been an unfortunate reality that a difficult year for the markets has coincided with such a large spike in the cost of living, intensifying the pressure on our pockets. It goes without saying that as the recession endures through 2023, some investments will suffer from the economic downturn more than others.

Fortunately, however, decumulation is not something we simply have to accept. There are numerous avenues that savers can explore to mitigate the aforementioned risks, weather the storm and possibly even find unique opportunities which could reverse the tide of decumulation.

Firstly, it’s important to note that the cost-of-living crisis will come to an end. The Bank of England has said the headline rate of inflation reached its peak in October. Many of the supply bottlenecks which initially caused inflation to rise are now easing and, though the living squeeze is likely to grind on through the first half of 2023, the Bank then expects inflation to fall sharply. Until then, there are certain lifestyle decisions, as well as efficiencies in your home, you may wish to make to reduce your need to drawdown more income. We explore them in this article.

Opportunities for growth

Secondly, while there are undoubtedly assets which struggle through periods of recession, there are always others which will do much better, and recessions can often present a good time to buy into certain markets while they are down. Your investment adviser will be able to identify opportunities, matched to your risk profile, which are more likely to grow in the coming years.

Meanwhile, the government’s decision to maintain the triple lock through this period of high inflation will mean a very welcome double-digit increase in the state pension in 2023. Higher inflation also means better saving rates than we’ve become accustomed to over the last 15 years, and it has fuelled somewhat of a comeback for the annuities market. With annuity rates higher than they have been in a long time, a trusted Independent Financial Adviser will be able to explain all of the benefits and drawbacks of purchasing an annuity to support your retirement.

De-risking decumulation

Crucially, a financial adviser will also ensure you are taking advantage of all available tax reliefs and allowances. During times such as now when decumulation is a greater threat to your portfolio, making savvy tax decisions is even more important. This includes looking at annual Individual Savings Allowances, Capital Gains Tax, married couple’s tax allowances and tax relief on pension contributions.

“I just did an annuity quote for a client at 6% says Mark Rodgers. So when the chips are down in other markets, let's have a look at alternative ways that perhaps haven't been on your agenda previously. That's the point of having financial advice: to come up with something else when external factors affect Plan A.”

“It can be easy to get suckered in by negative headlines, but there are always opportunities. Have you got investments or pension funds that you have not looked at for the last five years? Speak to your financial adviser for an objective and most importantly bespoke view of your individual circumstances. We provide expert advice but, almost equally as importantly, reassurance.”

If you are worried about decumulation and would like to speak to one of Ascot Lloyd’s Independent Financial Advisers about a plan for growth, click here to request a call back.