Planning for later life has become much more complicated in recent years.
Typically, you tried to accrue as much as possible – if you were in a defined contribution scheme – and bought an annuity when you came to retire.
But now there is much more choice. Many more people are in DC schemes, and how you accrue that pot is more open to question.
And when you reach retirement, there are many more choices available, and factors to take into consideration, such as how much of one's savings to take and when; will the client carry on working, and by how much?
Now there is an additional complication of Covid-19.
When it broke out, there was an immediate and sudden impact on markets.
While they have since recovered a little, the full economic impact of Covid-19 is only just starting to make itself felt. So it is clear we are not out of the woods yet.
The biggest factor is the sheer unknown; even if it makes sense that as the world goes back to work the economy should improve, but the speed at which the economy returns is driven in large part by how the virus is managed.
For those who were planning to retire imminently, they may have to ask some tough questions: can I afford to retire now? Can I live on a reduced income or should I work for longer?
For others, experts suggest staying calm and sitting it out.
Many are expecting a recovery, and the best thing, experts suggest, is to be in the market and to take advantage of the upswing when it comes, rather than be too late and be forced to buy assets at inflated prices.
This guide aims to address these issues and highlight the options available to clients, wherever they may be at various points on their retirement journey.
Needless to say, the most important thing is to start saving early, although many young people may be more preoccupied with immediate financial security rather than long-term saving. But making the right choices at every stage in retirement is crucial in getting the best outcome.
When to start thinking about retirement
The average income people feel they need in retirement to achieve their goals is £34,000 a year.
This means a person would need to have around £900,000 in pension savings to achieve that, according to a report by Sanlam late last year.
The average UK adult has a target pension pot of £355,000,
Unsurprisingly, the average person in the UK is miles from that target.
In reality, the average UK adult has a target pension pot of £355,000, which would generate an estimated annual income of £13,000 – some £20,000 below the desired income.
So what are the ways in which people can build a retirement income that is closer to their aspirations, and what are their options?
Never too early
The first thing to note, according to retirement specialists, is that it is never too early to be thinking about retirement.
Many people might have disposable income that they are able to save, but that is before they get financial commitments in life, such as marriage, a house, and children.
Fiona Tait, technical director at Intelligent Pensions, says: “You need to build up substantial savings in order to provide an income which may have to last over 20-30 years.
"And starting young will spread the load and avoid you having to play an expensive game of catch-up later on.”
Those in their 20s and 30s can start getting into that habit through auto-enrolment.
However, the majority of schemes allow individuals to contribute from the age of 18 onwards – and the earlier they start and the more they pay, the greater the flexibility in age and amount.
Self-employed individuals will have to make up their own minds to start saving and should try to factor in contributions to a pension each time they make a tax return.
Ruth Dolan, a chartered financial planner at Tarvos Wealth, says: “For the self-employed, a personal pension arrangement would meet the requirements and many providers provide an automated advice service.
“If you are keen to get advice and have the pension reviewed each year to ensure it is performing as expected and that it continues to be suitable for your circumstances, taking advice from a regulated, independent financial adviser will be very helpful.”
Ms Tait recommends that people should start to take retirement planning more seriously in their mid to late 40s.
“By this time they may have built up a number of separate pension pots, and the first step should be to identify and contact them all, and then to obtain valuations and projections of the pension they are likely to get from each,” she adds.
“This is currently easier for some pension plans than others, and it can take a number of weeks to achieve, at least until the pension dashboard is up and running.”
According to Aegon’s latest Retirement Readiness survey published in May, workers globally, including in the UK, expect that they will need on average 67 per cent of their current income in retirement, but relatively few say they are on course to meet these needs (25 per cent globally, 24 per cent UK).
The two most often cited retirement concerns among people globally are declining physical health and running out of money
Aegon have this year published a report entitled The New Social Contract: Age-Friendly Employers, which is based on findings from the company’s 9th annual global survey of 15 countries spanning the UK, Europe, the Americas, Asia, and Australia that was conducted in 2020.
In last year’s report, the two most often cited retirement concerns among people globally are declining physical health (50 per cent) and running out of money (40 per cent).
Workers expect to live to a median age of 80 and spend five years in declining health. A quarter (24 per cent) of people globally are concerned about their current health, and 43 per cent are concerned about their future health.
As many as one in three people (32 per cent) feel stressed about their current financial situation at least once a week, while one in four (24 per cent) feel stressed about their long-term plans for retirement.
According to Kate Smith, head of pensions at Aegon, by the time individuals hit their mid 40s they should be reviewing how much they have saved, what income they aspire to in retirement, and when they want to retire, both partially and fully.
Ms Smith says: “There are plenty of online tools to help people plan for retirement and work out how much they will need to save.
“They should be thinking about their workplace pension savings as well as any personal pensions. They may have other savings such as Isas, which are also useful for retirement planning.
“People can build in flexibility on the amount they can afford to save, whether consolidation is an option and whether they can bring forward their retirement date or have to put it back due to a lack of savings.
“It’s increasingly common for people to phase into retirement, dialling down working hours before they stop working altogether.”
Once the projected pension is known, this should be followed by a ‘shortfall analysis’ to identify if the current level of saving is sufficient to support income needs for the duration of retirement, Ms Tait explains.
This can be done using the free tool on the Money Advice Service website, and repeated on a regular basis. However, speaking to a financial adviser for a more in-depth analysis at least once in the 10 years prior to the date when access to the pension fund is likely to be needed would be very useful.
Ms Tait adds: “If a shortfall is identified, this process allows a reasonable timescale for additional contributions to build up the necessary funds.”
Retirement planning falling short
The study by Aegon last year also found that only 29 per cent of workers are extremely or very confident that they will be able to retire in a lifestyle they consider comfortable – indicating a understanding that retirement planning is falling short of what is required.
Workers expect that they will need to replace 68 per cent of their current income in retirement, yet only 25 per cent feel they are on track to achieve that level of retirement income.
Hannah Owen, financial planner at Quilter, says that before contributing to a personal pension, a client should look at up to what level of contributions their employers will match.
For example, if a client is able to invest a further £100 a month and the employer would match this if it is invested in a company pension, this should be considered before a personal pension.
Ms Owen adds: “If they are able to save above and beyond this, then a personal pension allows them to take control of how their pension is invested.
“If their workplace pension is final salary, then a defined contribution personal pension will give them a wider variety of income options in retirement.”
Intelligent Pensions’ Ms Tait adds: “Directing any additional pension savings to the existing workplace pension is likely to be a cost-efficient option as charges are often lower and will also be offset by the employer contributions.
“However, some savers prefer to set up a more bespoke plan, which allows them to choose from a wider range of investment and income options at retirement. This is more likely to be suitable in the years immediately before retirement benefits start to be paid.”
How to allocate one's savings
Many people feel uncomfortable or wary about making decisions about which investment to choose in the pension scheme.
It is the engine of the pension scheme and the way the investment performs which will have a big impact on what the pot will grow to at retirement, Ruth Dolan, chartered financial planner at Tarvos Wealth, says.
By this, she means that the investment fund which sits within the pension wrapper is what drives the eventual benefit that will be available.
A pension is a tax wrapper that provides the tax benefits such as tax free growth and tax relief.
Inside the pension, will be one or a few investment funds.
The way these funds perform is key to the eventual pot that will be available at retirement. If the investments perform well, the pension pot will have more to provide retirement benefits.
If they perform badly or if a fund which is unsuitable for the investor’s objectives is included, there may be less at retirement.
By calling the investment the 'engine', Ms Dolan is trying to illustrate that it is the key to providing what the investor will need and therefore, important that it is kept under review.
Ms Dolan says: “The bigger the pot, the more benefit you will get in retirement so it is very important to make the right choices.”
Generally, the further off an individual is from their retirement date, the higher their risk tolerance is likely to be.
Therefore, this risk should reduce the closer they get to retirement.
Hannah Owen, a financial planner at Quilter, says a client might wish to use drawdown, meaning that their pensions can remain invested while they take an income.
“In which case, if you did not invest your pension and had it in cash at this point, the value would be eroded by inflation,” Ms Owen says.
It is expected that the more risk someone is willing to take then the more gain they could potentially have in their funds over time, however equally they could also suffer higher losses in these funds.
Caroline Cochrane, partner at Crandles and Co, says there are now many risk-targeted funds which, once you have decided how much risk you are prepared to take, maintain your risk within the fund and do not allow the risk to either drift higher or lower.
Ms Cochrane adds: “Look for words like defensive, cautious, balanced and growth - moving up the risk scale - to give an indication which funds are likely to match the amount of risk you wish to take.
“Many fund documents give an indication on a scale of 1-5 for the amount of risk within a fund but if they use the words above, the funds should remain within these risk bands.”
Ian Evans, head of later life planning at Fiveways Financial Planning, says it is widely thought the longer timeframe you have to retire/invest, the more risk risk can be taken in the portfolios chosen, as it is widely accepted that long-term investing in the markets provides greater returns than cash or fixed interest based investments.
Mr Evans adds: “Investment markets do rise and fall – as we are now experiencing with the Covid-19 pandemic.
“The advice is and always has been, to stay invested and not to panic, as markets always recover over time.
“After the last significant market downturn in 2008, the FTSE 100 took two and a half years to return to pre-correction levels. In fact each time there has been a significant correction, the markets have taken less time to recover.”
As pensions are long-term investment plans, Fiona Tait, technical director at Intelligent Pensions, explains that an element of equity exposure will be necessary to achieve growth in excess of inflation.
Ms Tait adds: “Generally, the equity element should be at its highest level when people are a long way from retirement and can afford to ‘sit out’ any market losses, and then reduce over time to protect the growth achieved so far.”
The equity element should be at its highest level when people are a long way from retirement
Workplace pension schemes offer managed investment options which are suitable for those who do not have the time or expertise to manage their pension fund for themselves.
These ‘default’ solutions incorporate an element of equity exposure which means the funds are likely to outperform any cash investments, and often also have ‘lifestyle’ options which manage exposure to equity markets over time.
So, all workplace pensions offer a default fund, which is often a lifestyle fund.
These funds are designed to lock in investment growth as an individual approaches retirement.
The investments are automatically chosen based on the employee’s age and the timescale to retirement.
The principle is that the younger you are, the more exposure your investments can comfortably have to investments that are linked to the stock market, that is, company shares.
These are generally the most volatile types of investments, as the values can fluctuate daily, however they also generally provide the best returns over the long term.
Ms Dolan says: “It is important that the pension savings keep pace with inflation over time, at the very least, and investing in shares should provide this and more hopefully.”
It is important that the pension savings keep pace with inflation over time
Lifestyling involves investing in riskier assets, such as equities, when there’s a long time before the individual plans on taking their benefits, as further explained by Ms Smith.
She adds: “Typically five to ten years before the retirement date, funds are automatically switched to less risky assets such as fixed interest or gilts, which aren’t affected as much as equities if investment markets fall sharply in the run-up to retirement.
“This helps to protect the investment growth built up in the period to retirement.
“This transition to less risky assets, or the glidepath, targets the individual’s retirement date. So it’s important that if an individual wishes to retire earlier or later, that they tell their adviser or pension provider, so adjustments can be made to the glidepath.”
Lifestyling, where the funds are gradually moved into less risky holdings and then eventually into cash at retirement age is designed to reduce risk in your pension as you near retirement.
However, many people do not stop work at the age the pension was set up for, either opting to continue working or deciding to stop early, Ms Cochrane says.
“A drawback of “lifestyling” is that you may wish to take benefits either before the fund is in cash or you have been in cash for several years and missed growth opportunities,” she adds.
Although, lifestyling can help reduce the level of risk when approaching retirement, Helen Medhurst-Jackson, a chartered financial planner at Investec Wealth and Investment, says Lifestyling does not take into consideration changes in economic or market conditions that may have a negative impact on the lifestyling strategy.
She adds: “When considering which funds to choose it is always important to diversify between different asset classes, which reflects the individual's risk strategy and capacity for loss. So for example not to invest 100 per cent in equities or conversely 100 per cent in cash."
Ms Tait says a more personalised strategy may be achieved within a personal pension or Sipp.
She adds: “People with personal pension plans have access to a much wider choice of investment funds and can work towards a number of different investment targets instead of trying to fit into a standard member profile.”
Stay on course for retirement
Covid-19 has had a huge impact on shares’ values over the past few months, and that is assuming the economic fallout is only just starting or that the economic forecast is going to be a bumpy one.
So how should clients plan for the next five, 10 or 15 years?
The first thing advisers say is not to panic and to really understand what you have in your pension.
According to Ruth Dolan, chartered financial planner at Tarvos Wealth, there are some key questions clients should be asking:
- How is the fund invested?
- How has it performed relative to the average of other similar funds?
- What is the length of time to retirement?
- How do they think they might take their retirement?
- Do they have other assets or pension schemes?
- Are they planning to gradually retire rather than stop completely and use the pension to buy an annuity?
Ms Dolan says if the pension has a lifestyling strategy, it will automatically transfer the funds gradually from stock market holdings into lower-risk or cash holdings, the closer the client gets to retirement.
She adds: “It derisks the pension from the effects of high levels of volatility that may take place just before you retire.
“However, this may not suit someone who isn’t planning to use their pension until they are 70 or if they plan to use their pension at age 60.”
Other options include diversifying investments, particularly if the fund is invested in one area or asset class, for example, if it were invested entirely in FTSE 100 companies.
Ms Dolan says: “It may be preferable to switch to an actively managed portfolio or to a passive strategy if that is right for you.
“There isn’t a single right answer. It is important to take some time to understand what you have by way of pension features and investments and to think about what your retirement plan actually is.”
Where a client is close to their retirement it might seem as if their options are few.
A good portfolio, or single fund, should have more than stocks and shares in its investments
Kate Smith, head of pensions at Aegon, says: “If someone is only five years from retirement and they are in a workplace plan, the likelihood is that they have some or all of their pension funds invested in a lifestyle fund.
“This will give some protection against investment market volatility in the run-up to retirement.”
A good portfolio, or single fund, should have more than stocks and shares in its investments. Not all these assets will behave the same as stocks and shares, so it is important to invest in funds that offer more than stocks.
Caroline Cochrane, partner at Crandles and Co, says some assets will rise as stocks fall and vice versa, meaning they will not get all of the gain of the stock market but they should not have all of the loss either.
Continuing to contribute when markets are volatile is also worthwhile as funds can be bought “cheaply” when prices have fallen and can be held until prices rise once more.
The most important step to take in order to protect investments is not to sell to cash to try to avoid losses, Ms Cochrane adds.
She says: “Sometimes one has to sell, but this should only occur when other alternatives are not available.
“There have been times like these in the past and markets have recovered, certainly within a 10-year period and many within a five-year period and so the biggest takeaway should be: continue to contribute if you can and maintain investments in the meantime.”
Sometimes one has to sell, but this should only occur when other alternatives are not available
Echoing her thoughts, Hannah Owen, financial planner at Quilter, says: “One of the biggest things you can do is not to stray from your plan; for example, do not move to cash while the markets are volatile, with the aim of going back into the market when the volatility feels lower or when the markets seem to have recovered.
“This would mean you have taken a loss and permanently lost out on any upswing.”
For those retiring within five years, much will depend on the retirement income strategy and how much cash and income is needed in the early years.
Savers need support
This year’s Retirement Readiness survey report by Aegon states individuals have become increasingly expected to self-fund a greater portion of their retirement income and many are not fully equipped to do so. Now, the Covid-19 pandemic and economic downturn have exacerbated this already tenuous situation.
Mike Mansfield, programme director for the Aegon Center for Longevity and Retirement, adds: “Individuals are expected to save and invest for an increasing proportion of their retirement income.
“However, many people find themselves ill-equipped to do so and will likely face further financial pressures in the wake of Covid-19. Findings from this year’s Retirement Readiness Report confirm more support is needed for individuals to adequately prepare for their financial future.”
The report last year set out five fundamentals for retirement readiness:
- Start saving early and save habitually
- Develop a written retirement strategy
- Create a back-up plan for unforeseen events
- Adopt a healthy lifestyle
- Embrace lifelong learning
The survey also found that only 30 per cent of people globally could correctly answer all of the “big three” financial literacy questions developed by Drs Annamaria Lusardi and Olivia Mitchell that test knowledge of compounding interest, inflation, and risk diversification.
Fiona Tait, technical director at Intelligent Pensions, says she would normally advise people who are looking for a guaranteed income stream, in part or in full, during retirement, to significantly reduce the equity proportion of their pension funds within the last five years, so that a much smaller amount is exposed to market risk.
Ms Tait adds: “Those who have already done this prior to the Covid crisis will have experienced significantly lower losses than those who retained a high exposure to equities, although it must be remembered they will also experience less growth during the recovery.
“Those clients who had not yet reduced their equity exposure should be dissuaded from doing so until markets recover to previous levels, otherwise they will create an actual loss out of what is currently just a paper loss.
“Those who are a long way off from retirement have plenty of time to wait for a market recovery and the impact of the crash on the eventual fund is likely to be minimal.”
Those clients who had not yet reduced their equity exposure should be dissuaded from doing so until markets recover
Ms Tait believes the greatest impact of Covid will be felt by those within a few years of retirement and who were still heavily invested in equities.
She adds: “In most cases we would still recommend hanging on to the equity funds while markets recover, while reducing exposure by selling from the best performing funds over time.”
Options in retirement
If someone had been thinking about retiring soon, before the pandemic, they are probably now wondering if they can hang on a little longer as pension fund values have been hit by Covid-19 economic disruption.
But if continuing to work is not an option and the client is about to retire, what can they do?
There are many options that are dependent on each client’s specific circumstances and a review is essential, Helen Medhurst-Jackson, chartered financial planner at Investec Wealth and Investment, says.
Additionally, the questions an adviser should be asking their client include:
- Whether the level of income required initially can be reduced.
- Does the client have alternative savings that can be used to provide an initial income in retirement (such as National Savings & Investments)?
- Do they have access to the state pension?
- How should they review underlying investments to include more income-producing funds that could reduce capital erosion?
- If they cannot work in their existing employment, do they have the option to work in an alternative environment or be self-employed?
Do they have a partner/spouse who has an income on which they can initially rely?
Fiona Tait, technical director at Intelligent Pensions, says: “There is no getting away from the fact” that some people may have to delay their retirement as a result of Covid-19, however, there are steps that people can take to minimise the impact.
Ms Tait adds: “Some will already have reduced their equity exposure and others may find their fund value has now returned to something near the previous level.”
Even where this is the case, Ms Tait would still recommend looking to use other savings, especially any cash deposits, to fund early years of retirement.
She adds: “People are often reluctant to eat into their ‘rainy day fund’, however, the current situation is very much the definition of a rainy day and using these savings would avoid consolidating any losses in the pension fund.
“It may also be much more tax-efficient, for example, if the money is held within an Isa. Meanwhile the pension can be left to recover along with the investment market.”
She believes there is an argument for actually increasing equity exposure at this time in order to benefit from the predicted recovery, and to make up for losses sustained to date.
Ms Tait adds: “This is a good argument for people who are used to investing in equity markets and/or who have other savings to fall back on, however, I would counsel against it where the pension plan is the main source of income in retirement.”
Build in security
The government introduced maximum flexibility when taking benefits in April 2015, which means retirement income planning can be complex now with so many options available.
However, if retirement income drawdown plans already in place have been affected recently, an adviser should be speaking to their client about the effect of taking regular withdrawals from a portfolio that has fallen in value.
Ruth Dolan, chartered financial planner at Tarvos Wealth, says options might be to reduce or pause the income taken or adjust the investment strategy, while cash flow forecasting can be helpful to see what effect changing the risk attached to the portfolio might have on returns.
Ms Dolan adds: “Buying an annuity with part or all of the pension could provide security if you have been very worried by the recent falls but taking professional advice is vital, in this and any aspect of retirement planning, as any decisions made can have a lasting effect.
“If pension funds have experienced falls, withdrawing the fund to buy an annuity will crystallise any losses and you would lose the ability to benefit from any recovery that may take place.”
Buying an annuity with part or all of the pension could provide security if you have been very worried by the recent falls
For those looking to retire now, it is really important that sufficient security is built into a retirement income plan.
Individuals should be thinking about their expenditure in retirement and try to make sure that they will have enough guaranteed, secure income to cover the basic living expenses – their core income.
As Ms Dolan explains, this could be from the state pension, although this is being paid later and later, or the purchase of an annuity.
She adds: “There are lots of annuity options available, so it is worth making sure to check these.
“If you can secure enough income with money left over, this could be drawn upon as and when needed, to fund holidays, a car or other discretionary expenses.
“If there is a larger portfolio of savings, investments and pensions, it is possible to make some decent tax savings by planning how to meet your expenditure needs carefully.”
Stopping work does not mean you have to start taking pension benefits, particularly if you have other assets or savings.
You can defer taking benefits for as long as you wish or require to (up to your 75th birthday).
Caroline Cochrane, partner at Crandles and Co, says if the individual has been in a “lifestyling” fund they are likely to be mainly in cash and the stock market movements will not affect them.
But she would recommend against taking full tax-free cash, unless absolutely required, as this can be deferred if using flexible drawdown for income and the cash can be taken as and when required.
Ms Cochrane adds: “Two years’ income can be held in cash to avoid the market movements exaggerating the amount of fund required to provide income.
“If safer income is required then an annuity could be purchased, however, this removes flexibility and will require investments to be sold in order to purchase the annuity.
“Temporary annuities can be purchased which would allow for some funds to be held as investments but provide a short-term guaranteed income. Income needs can be revisited at the end of the annuity and decisions taken then about how to fund retirement in the future.
“I would absolutely not recommend increasing the risk taken with investments in order to chase income. This could have serious effects on the pension pot if markets remain unstable or there is another crisis similar to just now.”
Funding long-term care should also be considered, although it is difficult to plan long term for this.
However, there are some life assurance products on the market that offer cover against early onset of Alzheimer’s and dementia, and may pay lump sums towards care.
There are not many pre-funded care plans available either – although this may change.
Ian Evans, head of later life planning at Fiveways Financial Planning, adds: “My advice on planning for later life has always been, to save what you can, and to take out lasting powers of attorney, for both property and financial affairs, and health and welfare.
“Also, make a will and make sure it is up to date and reflects your wishes. It is generally a good idea to review it regularly – perhaps every five to 10 years.”