Introduction
The Pensions & Lifetime Savings Association (PLSA) recently updated their Retirement Living Standards and stated a comfortable retirement for a couple now costs £59,000 a year. These standards are based on independent research by Loughborough University and are something we share with our clients when discussing retirement expenditures.
We have also written a related article on what a modest retirement might cost for a single person and why it's best not to rely on headline numbers.
Mike and Jenny
To understand how much of a retirement pot might be needed to support this lifestyle, we will use an imaginary couple - Mike and Jenny Taylor. Mike and Jenny are planning to retire next year and are concerned whether this is still possible, having recently read how much these retirement numbers have increased compared to previous years' research. Mike is 63, and Jenny is 60, and they have total retirement savings of £800,000, consisting of the following:
They have no debt, and we are excluding their house from the balance sheet for simplicity.
1. Voyant: Baseline
We will start by building their financial plan using Voyant, our preferred cashflow planning tool, to see how feasible their plan is. We are using the following default assumptions:
Using this data, our first iteration shows the money running out (red is the shortfall) when Jenny is in her mid-70s, which we'd consider a failed plan.
For simplicity, we assume Mike and Jenny do not contribute to their retirement pot in their final year of work, and their investment balance remains unchanged.
2. Voyant: Adding state pension and changing expenditure assumptions
In iteration #2, we will look to make the plan more reflective of real-world scenarios:
Mike and Jenny have full state pensions (currently £10,600 per annum each), which we will add to the plan.
Expenditure tends to reduce as we age, and Mike and Jenny have decided to reduce their spending by 1% less than inflation each year (reduced from 3% to 2% in our Voyant modelling).
Things are now looking more positive, with Mark and Jenny relying on their state pensions at around age 90, but let's continue optimising the plan.
3. Voyant: Later life care, optimising asset allocation and taxation.
Later life care
Mike and Jenny would like to make provisions for later-life care. Our default assumption is to add three years' worth of expenditure at £55,000 per annum for the last three years of the older partner's life. This is based on research from LaingBuisson and Bupa on how much residential care costs and how long people typically stay in care (of course, a relatively small percentage of people need to pay for care, but we prefer to be prudent in our assumptions).
Optimising asset allocation
Mike and Jenny currently have £150,000 in joint savings. They would like to retain an emergency fund of around £20,000 (emergency funds are typically between 3-6 months of expenditure. In addition, we will leave the first year of retirement spending in cash (circa £60,000). This leaves £70,000 to be invested with the goal of generating superior longer-term returns versus leaving the money invested in cash. We will use their ISA allowances, with the remainder going towards General Investment Accounts (GIA). The amended balance sheet is shown below.
Optimising taxation
We have not yet set withdrawal logic in our cashflow planning. By default, we take cash first, then stocks & shares ISAs, then pensions. The lifetime taxation position (in nominal terms) is shown below.
We will alter Mike and Jenny's pension withdrawals to fully utilise their personal allowances. The withdrawals start at £16,760 each per annum, each tapering down to £2,626 once the state pension commences. The withdrawals will rise again once the cash and stocks & shares ISAs are exhausted - the idea is to optimise lifetime taxation to give Mike and Jenny the best chance of retirement success.
We can see how these changes have improved the sustainability of the retirement plan, but there is still some red in the plan, with later life care not currently funded.
Note that for real-world clients, we would create numerous "what-if" scenarios, including either Mike or Jenny getting run over and ensuring the surviving partner's financial plan remained robust.
4. Timeline: Baseline
Voyant is an excellent tool for building the retirement plan, optimising lifetime taxation and creating "what-if" scenarios. However, where we feel it falls short is in modelling real-world outcomes. If you've not done so already, we recommend reading our series on the 4% "rule".
This is where Timeline comes in. We will make the following assumptions for our baseline case:
Fees of 1.1%, which would be our total fees (approximately) per annum for this client
A portfolio comprising 60% developed market equities (stocks) and 40% bonds.
Taxation of £5,000 per annum from their late 60s onwards (once the savings and ISAs are nearly depleted).
How do things look? The short answer is "not good", with the plan succeeding in just over a third of historical scenarios!
The worst-case historical outcome had the money running out (only the state pension income remaining) in Mike and Jenny's mid-70s. The impact of taking more than 7% from the portfolio (£59,000/£800,000) in early retirement before the state pensions started could prove to be too much of a burden if Mike and Jenny were to experience a poor series of returns/inflation in early retirement.
5. Timeline: 100% equities
What if we increase the asset allocation to 100% developed market equities? Equities have outperformed bonds, on average, over the long term, so that should surely give a greater success rate, according to the data. This would seem to be the case at first glance, with the success rate increasing from 36% to 71%.
However, if we look at the worst case, the situation has deteriorated, with the money running out a year earlier. Bill Bengen also found similar with his research, finding a portfolio of between 50% and 75% equities to be the sweet spot to give the highest sustainable withdrawal rate.
6. Timeline: A more diversified portfolio
What if we adopt a more diversified portfolio, adding back bonds but also introducing emerging markets and tilting our portfolio slightly to small-cap value shares? Our portfolio at a high level contains 70% equities and 30% bonds, and at a more granular level consists of the following.
42% developed market equities (large and mid-cap).
14% developed small-cap value equities
14% emerging markets
30% bonds
Our success rate is broadly similar to the previous scenario, while our worst case has improved by a couple of years vs our 100% developed market equity scenario.
The big question is, is this a viable plan for Mark and Jenny? We would typically look at an overall success rate of around 80% (the portfolio lasting for the expected term) or more (effectively a 1 in 5 chance that the plan will need to be adjusted at some point to ensure success). We also look at the chance of the money running out when either Mark and Jenny are still alive.
Perhaps most importantly, we pay particular attention to the worst-case historical outcomes (the red line above) and consider what we might do to address this.
Based on the above, we would not be confident that this was a viable retirement plan.
7. Timeline: Mike and Jenny work another year and add £50k to their retirement pot - does that make enough of a difference?
The usual three levers to consider to make a retirement plan more successful are:
Work longer (which has the effect of making your retirement shorter AND means that you will typically save more money)
Spend less in retirement. Not an option for this (imaginary) scenario!
Take more risk. We have seen that taking more equity exposure doesn't necessarily improve worst-case outcomes.
Mike and Jenny push back retirement by a year and commit to saving an extra £50k during that time, bring the total to £850,000 at retirement.
Things are looking much more promising. The overall success rate is >80%.
While the worst case has the money running out around age 80. If Mike and Jenny were to suffer a series of poor returns in early retirement, small adjustments could be made in plenty of time to bolster plan success (see our article on risk-based guardrails to see how this might be implemented.
It's worth pointing out that we've focused on worst-case outcomes. If Mike and Jenny have average luck, their investment balance will be almost double (in real terms). In the best-case historical scenario, the ending balance was over ten times the starting balance! An adviser using risk-based guardrails should ensure the money was spent/gifted to prevent the (very fortunate) client from dying with too much money.
Conclusion
We've covered a fair amount in this blog and have barely covered the work required to build and maintain a robust retirement plan. We've covered the typical limitations of cashflow planning tools and why it might be best to use a tool that takes real-world inflation into account. We've seen how increasing the equity content of a portfolio doesn't necessarily improve worst-case outcomes, but diversification can help. Finally. we've seen how just one extra year of work and saving more can dramatically improve retirement outcomes.
Want to find out more?
If you want help with building a robust retirement plan, please get in touch.
About us
The team at Pyrford Financial Planning are highly qualified Independent Financial Advisers based in Weybridge, Surrey. We specialise in retirement planning and provide financial advice on pensions, investments, and inheritance tax.
Our office telephone number is 01932 645150.
Our office address is No 5, The Heights, Weybridge KT13 0NY.
Please note: This blog is for general information only and does not constitute advice. The information is aimed at retail clients only.