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Pension changes 2015: Could you run out of money before you die? | Pension changes 2015: Could you run out of money before you die? |
(about 13 hours later) | |
Even though the chancellor has now promised flexibility to anyone who has bought an annuity, many people will still be reluctant to buy one. | Even though the chancellor has now promised flexibility to anyone who has bought an annuity, many people will still be reluctant to buy one. |
For starters, no one yet knows how easy it will be to sell them back to the market. | For starters, no one yet knows how easy it will be to sell them back to the market. |
So under the changes coming in on 6th April, many retirees are likely to opt for the alternative, known as pension drawdown. | So under the changes coming in on 6th April, many retirees are likely to opt for the alternative, known as pension drawdown. |
This means keeping your pension pot invested, and drawing an income from it, as and when you need it. | This means keeping your pension pot invested, and drawing an income from it, as and when you need it. |
But if you take this route, you will be taking two big gambles. | But if you take this route, you will be taking two big gambles. |
First, how long do you think you will live? | First, how long do you think you will live? |
And second, how much income can you afford to take from your pot? | And second, how much income can you afford to take from your pot? |
Get either of those wrong, and you could easily run out of money before you die. | Get either of those wrong, and you could easily run out of money before you die. |
Withdrawal | Withdrawal |
In answer to the first question, life expectancy once you've reached the age of 65 is currently 83 for men in England and Wales, and 86 for women. | |
But the danger - in pension terms - is that they may well live very much longer. | But the danger - in pension terms - is that they may well live very much longer. |
That is why deciding on the second issue - the rate at which you can afford to deplete your pension pot - is so important. | That is why deciding on the second issue - the rate at which you can afford to deplete your pension pot - is so important. |
The chart below shows how quickly you can use up your money. | The chart below shows how quickly you can use up your money. |
Someone with a pension pot of £100,000 who withdraws at 6% a year - ie £6,000 - will in theory run out of money in 26 years. | Someone with a pension pot of £100,000 who withdraws at 6% a year - ie £6,000 - will in theory run out of money in 26 years. |
Someone who withdraws 5% a year could expect their fund to last much longer: 35 years. | Someone who withdraws 5% a year could expect their fund to last much longer: 35 years. |
And this calculation assumes the remaining pot grows at 6% a year. | And this calculation assumes the remaining pot grows at 6% a year. |
Should it only grow at 4%, the person taking £6,000 a year will run out of money in just 19 years. | Should it only grow at 4%, the person taking £6,000 a year will run out of money in just 19 years. |
Stock market | Stock market |
The trouble with the chart above is that it only shows the theory of what should happen to your pension pot. | The trouble with the chart above is that it only shows the theory of what should happen to your pension pot. |
Indeed Ned Cazelet, the consultant who produced it, calls it a "fantasy". | Indeed Ned Cazelet, the consultant who produced it, calls it a "fantasy". |
For according to how the stock market performs in reality, all those theoretical calculations could go, well, to pot. | For according to how the stock market performs in reality, all those theoretical calculations could go, well, to pot. |
So the chart below shows what would actually have happened to an investment pot of £100,000, had it been invested in 2000. | So the chart below shows what would actually have happened to an investment pot of £100,000, had it been invested in 2000. |
In 2001 and 2002 markets fell, wiping away nearly half the value of the savings. | In 2001 and 2002 markets fell, wiping away nearly half the value of the savings. |
Although share values later recovered, that early damage was a killer blow - resulting in rapid erosion of the capital. | Although share values later recovered, that early damage was a killer blow - resulting in rapid erosion of the capital. |
In 2007 and 2008 the same thing happened again. | In 2007 and 2008 the same thing happened again. |
"Lots of people lost money very quickly," says Mr Cazelet. | "Lots of people lost money very quickly," says Mr Cazelet. |
"If you do have these slips, you can find yourself going down the hill, and the brakes have failed. You'll never get back up there." | "If you do have these slips, you can find yourself going down the hill, and the brakes have failed. You'll never get back up there." |
Thus anyone withdrawing £6,000 a year from their pension fund would have run out of money this year - just 15 years after starting it. By withdrawing £5,000 a year, they would at least still have £31,000 left in their fund. But even that might only ensure a further six years of payments. | Thus anyone withdrawing £6,000 a year from their pension fund would have run out of money this year - just 15 years after starting it. By withdrawing £5,000 a year, they would at least still have £31,000 left in their fund. But even that might only ensure a further six years of payments. |
Natural yield | Natural yield |
So how much should you withdraw from a pension fund to make sure it lasts for as long as you want it to? | So how much should you withdraw from a pension fund to make sure it lasts for as long as you want it to? |
Some experts talk about a notional "4% rule". | Some experts talk about a notional "4% rule". |
"Taking around 4% per annum is relatively safe, and gives you a good chance of not using up your capital," says Richard Parkin, the head of retirement at Fidelity Worldwide Investment. | "Taking around 4% per annum is relatively safe, and gives you a good chance of not using up your capital," says Richard Parkin, the head of retirement at Fidelity Worldwide Investment. |
Pension Calculators | Pension Calculators |
State pension calculator DWP | State pension calculator DWP |
Combined state, workplace and DC calculator, from Standard Life | Combined state, workplace and DC calculator, from Standard Life |
Should I delay buying an annuity? Hargreaves Lansdown | Should I delay buying an annuity? Hargreaves Lansdown |
How much can I earn from a DC pot? Money Advice Service | How much can I earn from a DC pot? Money Advice Service |
But others think even this could be too high, especially if markets perform badly. | But others think even this could be too high, especially if markets perform badly. |
So the alternative is to take only the natural yield from investments. | So the alternative is to take only the natural yield from investments. |
In other words, to take the annual dividend pay-outs in the case of shares, or the coupons in the case of bonds, but to leave the rest of the capital untouched. | In other words, to take the annual dividend pay-outs in the case of shares, or the coupons in the case of bonds, but to leave the rest of the capital untouched. |
This approach is advocated by Tom McPhail, of Hargreaves Lansdown, who believes natural yield is a good starting point. | This approach is advocated by Tom McPhail, of Hargreaves Lansdown, who believes natural yield is a good starting point. |
"If you start drawing on an income pot at the age of 60, you might still be alive at the age of 90," he says. | "If you start drawing on an income pot at the age of 60, you might still be alive at the age of 90," he says. |
"Any run-down of capital over that time span could potentially get you in to trouble." | "Any run-down of capital over that time span could potentially get you in to trouble." |
With careful investing, a natural yield should allow an income of 3% or 3.5%. | With careful investing, a natural yield should allow an income of 3% or 3.5%. |
Spend it | Spend it |
In an era of low interest rates, annuities may well be out of fashion. But most experts are advising their clients to be extremely careful about relying on income drawdown products. | In an era of low interest rates, annuities may well be out of fashion. But most experts are advising their clients to be extremely careful about relying on income drawdown products. |
Mr Cazelet's study, "When I'm 64", shows how poor market performance in the early years of retirement can be particularly damaging. | Mr Cazelet's study, "When I'm 64", shows how poor market performance in the early years of retirement can be particularly damaging. |
"I'm not saying that drawdown arrangements are bad, but the client and his advisers need to understand what the risks are," he says. | "I'm not saying that drawdown arrangements are bad, but the client and his advisers need to understand what the risks are," he says. |
Mr Parkin suggests that people in retirement need to have some form of regular income first - such as a defined benefit company pension or an annuity - before considering a drawdown pension. | Mr Parkin suggests that people in retirement need to have some form of regular income first - such as a defined benefit company pension or an annuity - before considering a drawdown pension. |
"You should have some guaranteed income to cover your living expenses," he says. | "You should have some guaranteed income to cover your living expenses," he says. |
"People need to know that they can sleep at night, and to know they're always going to have somewhere to live and something to eat." | "People need to know that they can sleep at night, and to know they're always going to have somewhere to live and something to eat." |
Equally well, he also sees an opposite problem: people being so frightened of running out of money later on, that they do not spend enough of it. | Equally well, he also sees an opposite problem: people being so frightened of running out of money later on, that they do not spend enough of it. |
"If people are worried about losing their money, they could end up not touching it at all, and not enjoying the retirement they want to have," he says. | "If people are worried about losing their money, they could end up not touching it at all, and not enjoying the retirement they want to have," he says. |
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