A retirement plan built to be flexible, diversified and sustainable over the long term will withstand periods of short-term volatility and enable you to live the life you want to live.
Everybody wants a retirement which enables them to live out the lifestyle they want without having to worry about how it is paid for. When this is achieved, which can be through strong and flexible financial planning, it can ensure your twilight years are the happiest of your life.
It also means periods of high inflation and volatility in the markets, such as in recent weeks when sterling, equities and bonds simultaneously dipped in value in the middle of a cost of living crisis, do not fill you with worry about how you’ll pay the bills and sustain your lifestyle.
While undoubtedly helpful, the reality is a State Pension is unlikely to be enough to fund your lifestyle and you also won’t get it until State Pension age (currently 66). At the heart of most successful retirements is a good alternative pension, typically now taken through drawdowns and underpinned by investments rather than a guaranteed ‘final salary’ pension.
This means the value of the pension can go up and also down depending on the performance of your investment portfolio. Over the long term, a well-formulated investment portfolio will typically be on an upwards trajectory, meaning the value of your pension grows over time. However, short-term dips are to be expected. Your Independent Financial Adviser from Ascot Lloyd will have created a retirement plan robust enough to withstand these dips. Investment involves risk.
The challenge more recently is the dips have not only affected more markets than normal – generally, gilts were deemed a safe haven during disruptive times in the stock markets however the government’s mini-budget triggered widespread volatility – but a contraction in the value of some pension funds has coincided with a time of high inflation.
It is for this reason that expert financial advisers build retirement plans to be flexible and diversified, with a strong emphasis on long-term sustainability. Such is the importance of sustainability, your Independent Financial Adviser at Ascot Lloyd will keep a regular eye on your retirement plan to see when changes might be necessary. They will also be constantly reviewing external factors that might impact your income such as fiscal and monetary policy.
“When I visit clients for their annual review, particularly those who have retired, it’s very important to ensure the income they're drawing is still sustainable,” says Ken McIntosh, Independent Financial Adviser at Ascot Lloyd. “As we’ve seen recently, both monetary and fiscal policy are important because they affect the equity and bond markets and a pension fund's value, if it's a money purchase arrangement, is influenced by what markets are doing.
“If markets are doing well, that pot is growing nicely and the retirement income is sustainable – happy days. But if you’re taking more than the fund is growing, you don't have to be an economist to work out that at some point the money will run out. That's why we do a sustainability check. If the income is no longer sustainable, we will have to change things. You might have to adjust your risk level, withdraw less money, or reduce your expenditure.”
Cost of living
Withdrawing or spending less is likely to be challenging amidst rising inflation, but making certain lifestyle changes in the short-term will help maintain the long-term sustainability of your retirement income. When inflation is high, pensioners using income drawdown to fund retirement must withdraw more to achieve the same level of purchasing power, increasing the risk of running out of money or having to reduce their pension income in the future.
The key is not to panic, and to see the light at the end of the tunnel. Your Ascot Lloyd Financial Adviser can help you do both, providing reassurance that your long-term financial plan remains on track because it was assumed there would be peaks and troughs along the way. When markets dip, it is likely that they will at some point in the not so distant future, rise again.
Sometimes during periods of market volatility people have a natural instinct to take money out in cash, as it appears safer that way. There are a number of things wrong with this theory, however. Firstly, nobody knows when the markets will reach the bottom and pick up again, so taking money out crystallises any losses suffered already and creates the difficult position of guessing when to go back into the markets. Secondly, one asset almost guaranteed to lose value is cash, even more so when inflation is rising as quickly as it has.
“Don't try to time the markets, it's time in the markets that's important,” says Ken McIntosh. “As long as a portfolio is well diversified, without any undue risk, at some point it will get back on track. That’s why financial advisers are so valuable because they understand risk and they know how to diversify. They also recognise, when those rare occasions appear, when it might be wise to reduce income withdrawals for a short period or take a fresh look at expenditure.”
Ascot Lloyd uses cash flow modelling tools which are revisited regularly to reflect any major changes in income or expenditure, such as during periods of market volatility or faster inflation growth. Similar to how banks stress test new customers, cash flow modelling enables you to see how sustainable your income is should inflation rise, or your investment portfolio dips to unexpected levels. Meanwhile, your financial adviser will also keep a watchful eye on the legacy you wish to leave behind. A sustainable retirement income might be front of mind, but most people also want there to be a nice inheritance for their loved ones to enjoy.
Tax-free lump sum: take it or leave it?
More often than not, there will be a spike in expenditure in the first few years of retirement, especially if someone has used the opportunity to take a tax-free lump sum from their pension to treat themselves to a dream holiday, a new car, or to make home improvements. Spending then tends to decrease as people settle into their retirement and see the greater importance of sustainability as they could live another several decades.
The chance to withdraw 25% of your pension as a tax-free lump sum is an excellent perk, though any decisions should be considered carefully. When money is in a pension wrapper, it's very tax efficient. It’s built that way because the government wants to incentivise people to save as much into their pension as possible. Whenever you take money out of a pension wrapper, however, it might be liable to inheritance tax* should you die, and it be held in cash.
There is a lot of debate, meanwhile, around the merits of taking tax-free money out of a pension pot simply to reinvest it. If, for instance, you take a tax-free lump sum of £20,000 out to make use of your ISA allowance, that could be a good thing. But if you then die suddenly, ISAs fall into the estate for inheritance tax purposes whereas pensions don't.
If you take a tax-free lump sum to purchase an additional property which will, hopefully, appreciate in value over time as well as provide extra income, that could also be a good thing. However, purchasing and selling investment properties, as well as passing them on through inheritance, involve all sorts of taxes and fees which need to be taken into account. Any funds removed from a pension also immediately lose their ability to benefit from compound interest, which sees you earning interest on the interest that has already built up.
“These are complex decisions,” says Ascot Lloyd Financial Adviser, Ken McIntosh. “There has to be a good reason to take any money from your pension. If it's to pay off a mortgage, fair enough. If it's for spending, also fair enough, enjoy it, while of course understanding the impact on your future retirement income. But if it's just sitting in cash, that's always a danger, and if it's being reinvested into something else that may not be as tax efficient, that needs to be very carefully weighed up. Our job as advisers is to explain very clearly to clients the implications should they take a certain action, so they can make a fully informed decision that is best for their retirement.”
While it’s never too late to start building a robust retirement plan, it is undeniable that the earlier you start the better. Tax advantages provided by the government are designed in such a way that the sooner you start planning for retirement, the more options and opportunities will be available to you. While your twilight years might be the last thing on your mind in your 20s and 30s, there is no better time to start speaking to a financial adviser and creating a long-term financial plan that will stand you in good stead across your lifetime.
“Take advantage of all of the tax advantages and efficiencies that the government provides to incentivise people to save into their pensions.” Ken McIntosh adds. “Then when retirement is approaching, it's time to think about sustainability and lifestyle. There are charts and graphs published every year by various pension providers that show the longer you leave it, the harder it will be to build a sufficient retirement income. Even a delay of five years can have serious consequences by the time you hit 65. The earlier you can get there, the better.
“As soon as you’re in work, start paying into a pension. Neglecting to do so is like taking a voluntary pay cut, as it means your employer won’t pay into your pension either. The compounding effect of starting early is huge. My daughter is only 11 and we've already set a pension plan for her. We only put in £50 per month but by the time she's 18 it'll already be worth a fair amount. As Einstein said, compound interest is the eighth wonder of the world.”
If you would like to speak with one of the trusted Independent Financial Advisers at Ascot Lloyd about building a robust, flexible, retirement plan, please request a call back.