Many clients reach the point of retirement with a mixture of excitement and trepidation, as this marks the end of one era and the beginning of another. The end of a working career is a significant life event, and however you imagine retirement will look, it pays to begin planning well in advance, to give you the best chance of meeting your goals in later life.
Financial decisions taken at retirement are amongst the most important people make throughout their life, as the path chosen can have lifelong implications. Failing to have a solid retirement plan in place can introduce risks that could cause financial harm and make retirement less comfortable.
Failing to define objectives
Clearly defining income needs in retirement is a step many overlook. Understanding regular household expenditure and how guaranteed income, personal pension and investment income streams will meet these outgoings is an obvious starting point. Beyond essentials, irregular spending such as travel, hobbies and leisure also need to be accounted for, together with maintenance on the family home. Anyone who has enjoyed private healthcare through their employment may also need to set aside a budget if cover is to continue.
Whilst an initial income and expenditure calculation can prove helpful, this exercise really needs to be repeated at regular intervals as increases in the cost of living could outstrip increases in income, particularly from sources that are not guaranteed.
Failing to address sequencing risk
Drawing pension income through Flexi-Access Drawdown is a popular option that many select as part of their retirement plans. Under this approach, the pension fund remains invested, and withdrawals are taken at regular intervals to provide an income stream. In a fully invested portfolio, each withdrawal is funded by the sale of investments just before the payment is made. Through periods of relative market stability, the regular monthly sales to fund withdrawals will provide an average exit point from each invested position; in some months, market values will be higher, and some will be lower.
In periods of greater turbulence, however, selling investments to fund withdrawals may not be sensible, as markets may be temporarily mispricing assets. The early months of 2020 illustrate this well. As the scale of the Covid-19 pandemic became apparent, global equity markets fell heavily. Whilst markets had regained their poise and recovered losses by the end of 2020, selling investments to fund withdrawals during the period of increased volatility would have led to losses being crystallised unnecessarily.
Holding cash reserves when using Flexi-Access Drawdown through retirement is, therefore, essential, as this would allow withdrawals to be suspended at a time of market crisis, using cash reserves instead to plug the gap temporarily. As investment market conditions improve, cash reserves can be replenished, if required.
Investment losses that occur in the first year or two of drawdown can also have a detrimental impact on the longevity of a pension fund. The combination of withdrawals and investment losses shortly after commencing drawdown can accelerate erosion of the pension pot. This can be mitigated by adopting a diversified investment approach, holding funds as cash within the strategy, or phasing investment positions over several months.
Failing to ensure plans remain flexible
Life is unpredictable, and situations may arise where plans need to adapt to the change in circumstances. For example, a period of ill-health, which requires costly private medical treatment, or the need to undertake significant property renovations, can derail a sensible retirement plan. It may not necessarily be the case that plans are negatively impacted by life events. An example of this would be an inheritance received when retired which allows the rate of drawdown to be reduced.
Keeping retirement plans fluid can help ensure that they can adapt. Flexi-Access Drawdown is an excellent way of achieving this, as additional funds can be drawn if necessary, or income payments reduced as required. Investments other than pensions, such as those held in an Individual Savings Account (ISA) or General Investment Account, could be switched to pay out instead of accumulating income, if required.
Failing to review the plan
Keeping an investment strategy under review matters at every stage of life. A regular review can ensure that the strategy remains appropriate to changes in objectives, identify underperforming assets and take account of changes in economic conditions and an ever-changing tax landscape.
Through retirement, the need to review portfolio strategy on a regular basis only increases. Where a drawdown approach is adopted, close attention needs to be paid to the rate of attrition on the fund, with the aim of sustaining the portfolio throughout retirement. If necessary, the asset mix within a portfolio can be adjusted, or the rate of withdrawal changed to ease the pressure on the pension fund.
Scheduled reviews also provide the opportunity to step back and reassess the retirement plan as a whole. Annuities that pay a guaranteed income remain an option for consideration, and whilst they lack the flexibility of Flexi-Access Drawdown, they provide certainty. Annuity rates are closely linked to government bond yields, and therefore there will be periods when they look more attractive than others. Furthermore, changes in circumstances may merit a change in approach where an annuity becomes a more suitable option either in full or as a hybrid approach alongside funds held in drawdown.
At FAS, we undertake a thorough regular review process with our clients, meeting with them to ensure existing plans continue to meet their objectives. One of the benefits of our independent status is that we can recommend the most appropriate investment product or solution from across the marketplace that is tailored to each client’s circumstances. If retirement is on the horizon, speak to one of our experienced advisers to start a conversation.
