Managing your. The changing shape of retirement. income in retirement

Transcription

1 Managing your The changing shape of retirement income in retirement

2 This guide is for your information only and does not constitute advice. It sets out the four key issues you need to consider when deciding how to turn your pension pot into a retirement income. How long do you need to make your money last? It could be longer than you think. How much income will you need today and later on in retirement? How can you inflation-proof your pension? Should you keep your pension fund invested? This can bring benefits but means taking more risk with your money. What about your loved ones? Can you use your pension to provide for them when you are gone? By looking at these different issues we aim to show you how to build a robust retirement plan, designed to suit your needs. Guidance from Fidelity Fidelity Personal Investing does not give advice, but Fidelity s Retirement Service has a team of specialists who can provide you with free guidance to help you with your decisions. They can also provide advice and help you select products though this will have a charge which will be agreed with you in advance. Given the importance of the decisions you have to make at retirement, we strongly recommend you seek expert help. Call us on or visit fidelity.co.uk/retirement for full details of services and the fees. Of course you are free to use your own adviser. Guidance from the government The government offers a free and impartial guidance service to help you understand your options at retirement. This is available via the web, telephone or face-to-face through government approved organisations, such as The Pensions Advisory Service and the Citizens Advice Bureau. You can find out more by calling or by going to pensionwise.gov.uk. 2

3 The changing shape of retirement There has never been a better time to retire. We are living longer, enjoy more active lifestyles and due to greater flexibility around pension rules, now have more freedom to spend our pension savings as we wish. You no longer need to use your pension to secure a lifetime income. Those aged 55 or over are free to take what they want, when they want, from their pension savings. Some may still want to use their pension fund to buy an annuity, providing a secure income for life. Others may choose to dip into these savings on a more ad hoc basis, or even cash in one or more pension funds completely and use this money to pay off debts. There may even be the opportunity to enhance your State Pension. The upshot of this is that individuals now have the flexibility to use their pension savings in a way that suits them. However, in order to make the most of these pension freedoms, people need to think carefully about the type of retirement they want. In recent years there has been a fundamental shift in the way we fund old age, with less help from the state and employers, and more responsibility falling on individuals to provide for their own retirement. Savers need to plan their finances, to ensure they have sufficient money to provide a decent standard of living for what might be 20+ years of retirement. By looking ahead you can make sure you make the most of your pension savings and other investments, and use these freedoms to secure the lifestyle you want. 1: Living longer We should celebrate the fact that Britons are, on average, living longer and have more active lives. This means we need to think carefully about how we fund a longer retirement. Planning ahead is crucial. Too many underestimate just how long they will live in retirement and therefore run the risk of outliving their savings. To avoid this, the chart below gives people an idea of how long their pension might have to last. Being realistic about how long you will live, and just how much money you will need, is the first step to ensuring you have a secure and happy retirement. Lifespans can be longer than expected 65 year old man 65 year old woman 65 year old couple* 50% chance 89 yrs. 90 yrs. 95 yrs. 25% chance 96 yrs. 97 yrs. 100 yrs. * At least one surviving individual Source: Annuitant mortality data as provided by the UK Actuarial Profession s Continuous Mortality Investigation. Figures assume in good health. For illustrative purposes only. 3

4 Working longer One way to fund a longer retirement, is to push back the date at which it starts. Improved health, and increased longevity mean far more people now work beyond their normal retirement age, either on a part-time or full-time basis. For some this may be because they don t feel like slowing down yet; for others it is driven by financial necessity. The proportion of those aged 65 or over who are still working almost doubled between 2001 to 2013 from 5% to nearly 10%.* For many people, working beyond the age of 65 will be a necessity, not an option. The Government is increasing the age at which men and women get their State Pension. It will reach 66 in 2020 for men and women, then rise to 67 between 2026 and 2028, and keep on rising to 68 by At the same time the age at which people can access their pension savings will rise in line, from 55 to 58 by It is essential individuals know when they are entitled to get their State Pension. To check visit gov.uk/retirement-age. For those who want to continue working beyond their State Pension Age there is the option to defer taking this benefit. This increases the value of the pension when you do take it. Those deferring after April 2016 will need to defer for at least nine weeks. Your State Pension will then increase by 1% for every 9 weeks you put off claiming. This works out at just under 5.8% for every full year you put off claiming. * Source: gov.uk, December Building a retirement budget We ve established that if you are currently in good health you re probably going to live for a long time in retirement, so your money needs to stretch further. The next step is to calculate what this money has to cover. Draw up a realistic budget that covers day-to-day spending (household bills, food, any mortgage or rent) and essential luxuries, such as holidays. This should give you an idea of what income you need each year to continue living comfortably. In an ideal world these essential expenses should be covered by a secure income this would include the State Pension, a final salary or defined benefit pension or an annuity. If your day-to-day living costs exceeds the value of any State Pension, and/or final salary pension then you may want to consider using other pension savings to deliver a secure income. There are a number of ways that you can do this: You can use part of your pension fund to buy an annuity that will make good this shortfall. Remember if it s a fixed annuity it won t increase in line with inflation, whereas household bills are likely to increase over time. Alternatively you can look at deferring your State Pension, which will increase the amount of inflation-linked income you get but you will receive your pension later. You may have to work longer or spend private pension savings to cover living costs in the interim. On top of day-to-day expenses don t forget to make provision for unexpected expenses, such as the boiler breaking down. Many people don t factor such costs into their budget, and this can create difficulties later on. Another consideration is whether you ll need additional help and support as you get older, either in your own home, or in residential care. In most cases people are expected to contribute towards these costs. Those retiring may want to set aside money now to meet care costs, or consider insurance. Alternatively you may simply accept that you ll have to utilise other assets, such as your home to pay for this, should the need arise. 4

5 2: Inflation It is no surprise that inflation is sometimes known as the silent bank robber. Over longer periods of time it can seriously erode the value of your money. For those in retirement this is a serious problem. If you don t take steps to protect your pensions and savings against inflation, you are likely to find that their value and your living standards fall. But how do you ensure your savings stay one step ahead of rising living costs? One option is keep your pension fund invested in assets such as stocks and shares that are more likely to keep pace with inflation. These assets can protect the purchasing power of your income but they leave your pension exposed to investment risk. If investment values fall, then this may mean you need to reduce the income you take from your pension fund. If you continue to drawdown the same amount you run the risk that your money will run out sooner than expected. Investing for retirement income Once you have covered your day-to-day expenses with a secure income you will be in a position to consider how to invest your remaining pension savings. Some people prefer the certainty of an annuity where they know what their income will be. Others may be prepared to take some risk with surplus savings, with the aim of growing their retirement income over time and countering inflation. Pension drawdown is the most common way to achieve this. Here your pension fund remains invested and individuals draw a regular income from it. There are other options though. Some providers offer investment-linked annuities. These guarantee a minimum level of income but there is an opportunity for this to rise if the linked-investments perform well. There will be additional costs though in providing these guarantees. Another option is to buy an annuity that increases in value each year helping your income keep pace with inflation. Here, you aren t exposed to market risk, but these annuities can be very expensive. At the moment an inflation-linked annuity will mean your starting income is 56% less than what you d get from a fixed-rate annuity product.* You may have to live a very long time to make good this difference. * Source: Assureweb, April

6 3: How should you invest your pension fund? Those retiring need to think about how they would invest surplus assets, once they have secured an income to cover day-to-day expenses. Investors should look at using a mixture of investments. This is known as asset allocation and should include: fixed-income investments like gilts and bonds to provide a stable income. equity investments, such as shares and funds, with the aim of providing capital growth. cash deposits for immediate income needs. The exact amount you hold in each type of asset will depend on when you need the money and your attitude to risk. Generally, if you are likely to need this money in the next few years it should be in safer assets such as fixed-interest investments and cash. Money that is not needed in the short term could be in investments that have the potential to deliver higher returns but which may be more volatile. You need to make sure you are not taking an overly cautious or an overly aggressive approach. Both strategies could see your savings run out quicker than you would like. A cautious investment strategy may not generate sufficient returns to deliver the income you need over your retirement. As a result you could outlive your savings. Conversely, more aggressive strategies could also come awry. If you have too much of your money in higher risk assets this means increased market volatility leaving your fund vulnerable in severe market downturns. Remember if you are drawing an income from these funds this can make the effect of a falling market more pronounced. If you are not comfortable taking investment decisions yourself you might consider a fund that manages these decisions for you. Such funds invest across a range of asset classes and so are often called multi-asset funds. Multi-asset income funds can help manage risk at the same time as providing you with a regular income. Please note that you should regularly reassess the suitability of your investments to ensure they also continue to meet your investment goals and the time horizon for which you want to invest. You can find out more about investing for retirement at fidelity. co. uk/retirement. This explains investment strategies and some of the solutions you can use. 6

7 Managing market volatility Investing in retirement involves taking risk in order to grow your income. This can be particularly useful when trying to mitigate the impact of inflation. All investors have to live with market volatility, share prices go up and down and this will affect the value of their holdings. This volatility becomes more of a problem in retirement, when you are also taking an income from these investments. If the market falls, then the value of your drawdown fund is likely to fall too. If you are also taking income from this fund, these falls will be greater. But the main problem is that you are then left with a smaller fund to support future income payments and on which you are hoping for capital growth. Investors need to keep an eye on both the value of their fund, and the income they are taking from it to ensure their retirement plan remains sustainable over the longer term. Market volatility The chart shows the daily performance of the FTSE 100 Price Index from April 1996 to April ,000 Sustainable income If the value of your fund falls you may need to reduce the income you take from it, to ensure your retirement plan remains sustainable. If you do not, then you run the risk of your money running out far sooner than expected. However, this may not be easy to do if you are using drawdown to cover essential day-to-day living expenses. In such cases market volatility may have a negative impact on your living standards, or simply lead to you drawing down money too quickly and outliving your pension fund. This is why it is generally preferable to use a secure form of income to cover essential costs. This gives you more freedom to invest surplus funds and adjust the income taken from it, as conditions dictate. An effective investment strategy will aim to make sure that you do not expose funds needed in the short to medium term to too much risk. By doing this you can reduce the chances that market volatility will throw you off track. A combination of guaranteed income, plus drawdown gives people the peace of mind that day-to-day living expenses are covered, while providing the flexibility to invest for the longer term and counter the effects of inflation. 7,000 6,000 5,000 4,000 3,000 2,000 1, Source: Datastream Days to fall Days to recover Important Information: Please note that the value of investments can fall as well as rise and you may get back less than you have invested. Tax savings and eligibility to invest in a SIPP or ISA depend on personal circumstances. Pension drawdown is complex and may not be right for all clients, advice will need to be obtained and charges may apply. Pension drawdown income is not secure. You and your adviser, if you have one, control and must review how your pension is invested and how much income you draw within the applicable limits. Poor investment performance and excessive income withdrawals can deplete your pension pot leaving you with less income than you require. You need to be realistic about how tolerant to risk you are and to be aware of your capacity to withstand loss of capital, should markets go down. Past performance is not a guide to what might happen in the future. 7

8 4: Building your retirement plan Looking after loved ones When planning for retirement it is likely that a spouse, partner or other family members will have to be taken into consideration. Unfortunately, many people overlook the need to provide for their loved ones when they buy an annuity, with the majority of those sold being a single-life, rather than joint-life product. As the name suggests, a single-life annuity pays out until you die, but a joint-life annuity will continue to pay a pension to a spouse or partner. You can select the amount of income you wish a spouse or partner to receive on your death. It can be any percentage of your annuity income, up to 100%. Although the cost of a joint-life annuity may be higher as it may have to pay out for longer, it is worth considering, particularly if your partner or spouse does not have their own savings or pension to rely on. Given the importance of the decisions you have to make at retirement, we strongly suggest seeking expert help. If you already have a financial adviser, they will be able to help you plan for a successful retirement. Alternatively, you can call our retirement income specialists on If you are using pension drawdown or have yet to access your pension savings, then the value of your account will be available to your beneficiaries. Current pension rules mean that these funds are taxed more favourably on death than in previous years. Those who die before the age of 75 can effectively pass on these pension funds tax-free, subject to the Lifetime Allowance (LTA). If you die after your 75th birthday, those inheriting these assets will simply pay their marginal rate of income tax on monies withdrawn from these funds. These pensions aren t included in your estate for Inheritance Tax purposes. Other considerations: beware the taxman The income you take from a pension is not tax free. You receive tax relief on contributions you make into a pension fund up to the annual allowance, but when you convert it to a retirement income it is subject to income tax although everyone is entitled to take 25% of their pension pot as a taxfree lump sum. Before you start taking large amounts of money out of your pension, look at the tax implications. You could find yourself paying 40% or 45% income tax depending on how much of your savings you take. And if you take too much you may even lose your personal allowance meaning you pay an effective income tax rate of 60% on some of this income. You should also look at your pension in the context of other income you may be receiving from part-time work, other investments or property to ensure you draw your pension as tax efficiently as possible. Plan as a family and take into account the income, pension and savings your partner or spouse receives. As part of this tax-planning process think about how your pension will be taxed after you die. Current rules mean pension pots aren t subject to Inheritance Tax, but as stated above beneficiaries may have to pay income tax on these pension funds. 8

9 The best solution for you The key to planning for retirement is to combine different income streams to ensure you can live the life you want to lead. By diversifying the ways in which you receive income you can work out the best ways to reduce the effects of inflation, living longer, market volatility and tax. For many people combining a variety of income sources will be the best solution as the table below shows. We have also included a case study so you can see how this works in practice. Secure income such as State Pensions and defined benefit pensions will be the bedrock of your retirement plan to cover essential expenses. These will typically increase each year, to help counter inflation, and preserve the spending power of this income. Annuities also provide a secure income so you know your bills are covered but they generally do not offer flexibility or a chance to grow your money. Drawdown allows you the freedom to take as much, or as little income as you d like and increase your pension later in life. It can help you protect your income against inflation. But your savings will be exposed to market risk so there is always the danger of running out of money earlier than expected. Other savings and investments should also be considered in your retirement plan. These may include cash deposits, ISAs, stocks and shares and so on. As with a drawdown pension you need to think about how these savings are invested and consider how much risk you want to take with your money. Do these savings have to cover specific costs, generate a set income or are these rainy day funds? The sooner you expect to access these savings, the less investment risk you should normally take on. As this guide explains, there are several options you can consider for your retirement income. Some people may opt for just one, but we believe many investors will find that the best approach is a diversified income portfolio. This will use a tailored blend of income from pension drawdown and annuities that supplements all the other income they will receive such as the State Pension, any defined benefit schemes and other investments, such as ISAs. Our team can explain these options to you and help you decide exactly where to put your money. Consider how various income sources align with your objectives Income sources Strong alignment Moderate alignment Potential for income growth to keep up with inflation Lifetime income that will not run out due to longevity Predictable income to provide protection from market volatility Flexibility to meet changing needs and uncertainties Ability to leave benefits for your loved ones Drawdown pension investment portfolio with systematic withdrawals Non-pension investment portfolio with systematic withdrawals (e.g ISA) Fixed annuity with annual increases Defined benefit pension State Pension Combined income sources 9

10 Case study: David wants to balance risk and reward I will be 65 years old this month and would like to retire. I m entitled to 6,741 a year State Pension and also have a final salary company pension of 10,000 a year that goes up with inflation. I have a personal pension pot of 300,000 and an outstanding mortgage of 50,000. I estimate that I will need just under 18,000 a year before tax to cover my basic living expenses. What should I do with my pension pot? First step: clear the debt David is entitled to take 25% of his personal pension fund as tax-free cash, giving him 75,000 at retirement. It makes sense for David to use these funds to pay off his 50,000 mortgage. This means he doesn t have to meet mortgage repayments, and pay the interest on this debt, out of his pension income. Second step: covering essential living costs David has a solid base of guaranteed income from the State Pension and his defined benefit plan. Both will go up in line with inflation so he s well protected there. But he hasn t got quite enough to cover his basic expenses. What should he do? Defer State Pension and live off his pension savings for a short period Buy an inflationproofed annuity of 1,172 a year Take additional income from his personal pension using drawdown For each year that David defers* taking his State Pension it will be increased by just under 5.8%. So by deferring it for three years he will increase it by 17.4% to 7,913 (plus whatever the State Pension has been increased by because of inflation over that period). Together with his defined benefit pension he will then have more or less what he needs to cover his basic expenses and it will be protected from inflation for the rest of his life. He will need to cover excess expenses of 8,000 a year over the three year period. Assuming inflation is 2% a year this will take around 24,500 from his personal pension savings Inflation protection on annuities is an expensive option. The cost of buying an inflation-linked annuity of 1,172 per year (what David would get by deferring State Pension for three years) will cost him just over 40, This will cost nearly twice as much as what he d spend on the State Pension deferral option. This is another good option and David certainly has plenty of money to cover this. But the income he takes is not guaranteed and so David could find more of his money has to go on covering basic expenses than he intended, particularly if inflation is high and he lives a long time. Overall, it seems David will be better off deferring his State Pension for three years. He has 25,000 of tax-free cash left after paying off his mortgage and so can use that to bridge the gap for the three years. As he needs certainty of income he holds it on deposit with the bank but can increase his interest by locking it away until he needs it. * If you were entitled to your state pension before 06 April 2016, your deferral rate will be 10.4%. Third step: investing for income David has 225,000 left over from his personal pension. What can he do with this? Use a drawdown pension to stay invested and generate income Buy an annuity David can invest his remaining fund in a drawdown pension arrangement and access his savings as and when he needs to. Assuming he wants to draw a steady income then he could look at a starting income of between 4% and 6% of his portfolio which would generate between 9,000 and 13,500 a year. By investing in growth-oriented assets he could reasonably expect to increase this income over time to help mitigate the impact of inflation. This is not risk-free and if his investments perform poorly he might have to reduce the income he takes or accept the risk of running out of money sooner than expected. Alternatively David could buy an annuity. With his remaining fund of 225,000 he could buy a flat-rate annuity of around 11,563 2 per annum. An inflation-linked annuity would only give him a starting income of 6,509 3 a year. 10

11 As David already has his basic expenses covered he is happy to take some risk in order to grow his retirement income. He invests in a pension drawdown arrangement taking a modest income of 8,000 and investing reasonably adventurously with the aim of growing his income over time and keeping his options open for the future. He can decide as he gets older if he wants the certainty of a fixed income and can buy an annuity at a later stage. Other considerations This example shows that a mix of different income sources is often needed to achieve the best outcome. David used the State Pension, a defined benefit pension and drawdown to get the result he needed. For other people, different solutions might be better. It s important to look at all the options and consider which ones work best for you. We all have different priorities and expectations. The new pension rules enable us to tailor a retirement plan to suit our needs rather than accept a one-size-fits-all approach. Benefits on death Flexibility Management Under a drawdown arrangement any funds remaining on death can be used to provide income for loved ones or withdrawn as a lump sum. These payments may be subject to income tax at the beneficiaries marginal rate, depending on how old David is when he dies. If David had bought an annuity he could have chosen to have his pension continue to be paid to his wife on death although that would reduced the income he initially receives from this annuity. Once you have bought an annuity you can t usually reverse this decision. If David s circumstances change, say his health deteriorates quickly or he needs to fund unexpected expenses, he would almost certainly not be able to change an annuity contract. A drawdown pension gives him the flexibility to access more cash now, although this will have consequences on the income he can draw later in life. A drawdown pension arrangement needs to be reviewed regularly to ensure it remains on track and will continue to deliver a sustainable income. This involves reviewing and adjusting investments and perhaps income levels on a regular basis. David may be happy doing this himself or may need to get help from a specialist adviser. This will involve additional fees. In contrast, annuities generally need little maintenance once they are established. Important Information You cannot access the money held in a pension until minimum pension age which is currently 55 but will rise to 57 by This case study is relevant for those reaching State Pension age before April Younger people do not benefit from such generous terms to defer taking State Pension. This information is not investment advice and must not be used as the basis of any investment decision, nor should it be treated as a recommendation for any investment. Given the importance of the decisions you have to make at retirement, we strongly suggest seeking expert help. If you already have a financial adviser, they will be able to help you plan for a successful retirement. Alternatively, you can call our retirement income specialists on Source: Assureweb. Based on a male aged 65 with no health issues and a non-smoker. Annuity purchase price, after tax-free cash has been taken, of 40,500 based on single life, RPI-linked annuity with a 10 year guarantee payable monthly in advance. Figures correct as at March Source: Assureweb. Based on a male aged 65 with no health issues and a non-smoker. Annuity purchase price, after tax-free cash has been taken, of 225,000 based on single life, level annuity with a 10 year guarantee payable monthly in advance. Figures correct as at March Source: Assureweb. Based on a male aged 65 with no health issues and a non-smoker. Annuity purchase price, after tax-free cash has been taken, of 225,000 based on single life, RPI-linked annuity with a 10 year guarantee payable monthly in advance. Figures correct as at March

12 Issued by Financial Administration Services Limited, authorised and regulated by the Financial Conduct Authority. Fidelity, Fidelity International, the Fidelity International logo and F symbol are trademarks of FIL Limited. UKM0416/9741/SSO/0317