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£400,000 sounds like a lot of money, but is it enough to provide a comfortable lifestyle over 40 years of retirement – or more? After all, if you are looking to retire “early” – say, at 55 – then this is likely how long your fund will need to last, especially given today’s higher average lifespans. In this article, our financial planning team at Hanson Financial Services here in Liverpool offers some practical insights on this important topic below.
A complex picture
Figuring out how far £400,000 will go across 40+ years of retirement is difficult. First of all, there is the impact of inflation – whereby the “purchasing power” of each pound in your pension goes down over time. £400,000 in 2021, in other words, will not be worth £400,000 in 2050. Nobody can predict what inflation will look like over 4 decades, although the Bank of England’s (BoE’s) target rate of 2% per year is a good starting point. Assuming that average UK inflation reflects this over the next 40+ years, then this means your pension pot will need to grow by at least 2% per year just to retain its value.
This is before taxes, fees and other costs come into play, of course – which can also erode the purchasing power of your pension). In 2021-22, fortunately, generous UK pension rules mean that your pension contributions receive tax relief as you build up your pot (equivalent to your income tax bracket). Moreover, your savings are not subject to dividend tax or capital gains tax. Once you start taking an income from your pension, however, it is subject to income tax. This is a system that could change in the future under new governments – although this appears to be very unlikely any time soon.
Finally, the funds and platforms where your pension savings are invested charge investors so these can be run profitably. Here, you have more control as an investor. There is a wide range of funds available on the pension market in 2021, with many decreasing their prices over more recent years due to more competition. A financial planner can help you identify a good range of options suitable to your investment goals and risk appetite, mitigating unnecessarily high fees without compromising on performance and quality.
A helpful illustration
With all of this now stated, let’s imagine a scenario to see how far £400,000 could stretch in a retirement. Suppose John has saved this amount, is 55 and is looking to retire very soon. He is fairly comfortable with taking on higher investment risk, so is happy to invest most of his pension in equity markets over the coming years. These are likely to fluctuate in value as stock markets rise and fall, yet he assumes that an annual overall return of 8% is realistic.
However, John needs to take infations and investment costs into account. He subtracts 2% from this 8% figure, in line with the BoE’s target, leaving him with a target 6% average “real return” each year. Adding up all of his investment costs (e.g. fees, trading and advice), moreover, John assumes this will average about 1.5% per year – leaving a 4.5% real return. He then applies this to his £400,000 pension pot, which suggests that he can withdraw £18,000 without eroding too much of its value in the years ahead.
£18,000 per year might not sound like a lot. However, for many people, their cost of living when they retire goes down. After all, the mortgage is likely to be fully repaid, commuting costs are no longer needed and your children (possibly!) have left home. Others, however, may need much more to sustain their desired retirement lifestyle. If so, there are other options you can consider, which include:
- Delaying early retirement and working longer, to build up a bigger nest egg which could more realistically help you meet your retirement goals.
- Scale back on your desired lifestyle and retire earlier with the funds you have saved.
- Retire abroad to a country with a lower cost of living.
- Downsize and invest the property sale proceeds into your pension and/or an investment account (e.g. a Stocks & Shares ISA), which could help boost your income.
- Take a lower income earlier in retirement until you can access your State Pension from your state pension age, taking pressure off your own pension savings. Bear in mind that, if you retire at 55, then you could be waiting until age 68 (or later) to access this money.
There are other options you can consider, too. However, the key point is to plan carefully with an experienced, qualified professional when it comes to your retirement. It is easy to make costly, irreversible decisions on your own, which you may regret later. A financial planner can help you make sense of the complex pension rules and investment dynamics involved, giving you more peace of mind in the decades to come.
Are you interested in talking to a financial adviser about your pension and investment planning needs? We’d love to assist you here at Hanson Financial Services.
Please contact us to arrange a consultation with our team – free and without obligation – to gain more clarity and peace of mind over your financial plan.
You can call us on:
Liverpool Office: 0151 708 7616
Manchester Office: 0161 401 0991
Chester Office: 01244 960 039Or email via: [email protected]