Retirement is an exciting milestone, with more free time to dedicate to the things you enjoy. Yet, it can also be a daunting time, especially when it comes to managing your finances.
Flexi-access drawdown is a popular way to access your pension savings as it provides flexibility and means you’re in control of your income. However, it also means you’re responsible for ensuring you don’t run out of money.
With the pressure of managing pension withdrawals, it’s perhaps unsurprising that a study in IFA Magazine found that almost half of retirees are worried about spending too much too soon.
Indeed, statistics from the Financial Conduct Authority indicate some retirees could be withdrawing money from their pension at an unsustainable rate.
For example, more than 30% of people accessing a pension with a value between £100,000 and £249,000 in 2023/24, withdrew at least 8% of their pension. Some of these people may have other pensions or assets they could use to fund retirement, but others could find they face a shortfall in the future because they’re accessing their pension at an unsustainable rate.
One of the challenges of managing pension withdrawals is that some factors are outside of your control.
The known unknowns of retirement
When you’re planning your retirement income, you’re likely to need to consider known unknown factors – you know they will affect your retirement plan in some way, but accurately predicting exactly how they’ll affect you at the start of retirement isn’t possible.
The list of known unknowns might be lengthy and some won’t affect all retirees. However, there are three key variables that most retirees could benefit from considering when calculating their sustainable pension withdrawal rate.
1. Life expectancy
If you knew how long your pension needed to provide an income, you could simply break it down into even blocks and rest assured that you wouldn’t run out.
In reality, you don’t know how long your pension needs to last. The average life expectancy could provide a useful indicator, but it’s far from certain.
According to the Office for National Statistics, a 65-year-old man has an average life expectancy of 85. However, he also has a 1 in 4 chance of reaching 92 and around 1 in 10 will celebrate their 96th birthday. For a 65-year-old woman, the average life expectancy is 87, with a 1 in 4 chance of reaching 94 and around 10% will celebrate their 98th birthday.
So, if you based pension withdrawals on the average life expectancy, there’s a chance that you could outlive your pension by a decade or more.
As a result, erring on the side of caution when calculating how long you’ll spend in retirement could be useful. A retirement plan could help you balance long-term financial security with enjoying your early years of retirement.
2. Inflation
The income you’ll need to maintain your lifestyle during retirement is unlikely to be static. Instead, inflation will usually mean your income will need to increase each year.
The Bank of England (BoE) has an annual inflation target of 2%. While this might seem like it’ll have little effect on your income needs, over decades it could add up. In addition, the recent period of high inflation has highlighted that the cost of goods and services can rise at a faster pace.
According to the BoE, if you retired in 2018 with an annual income of £40,000, just five years later your income will need to have increased to almost £50,000 just to provide you with the same spending power.
Failing to consider the effect inflation might have on your needs and wealth could derail your plans.
Indeed, an IFA Magazine report suggests the number of retirees searching for a job increased by 16% in 2024 when compared to a year earlier due to rising living costs.
3. Investment performance
One of the potential benefits of choosing flexi-access drawdown is that your pension will usually remain invested. This provides an opportunity for your pension to generate investment returns.
However, it’s not always straightforward. The performance of your investments could have a direct effect on the sustainable withdrawal rate.
For instance, during a downturn, you’d need to sell a greater proportion of your pension investments to achieve the same income. This could mean you deplete your pension quicker than expected and leave a potential shortfall in the future.
When weighing up the effect of investment performance, you might need to consider questions like:
- What are my expected investment returns?
- What is an appropriate level of risk for me in retirement?
- How should I manage pension withdrawals if the value of my pension falls?
Regular reviews could help you assess investment performance and make adjustments to your retirement income when appropriate.
Other unexpected factors could affect your retirement finances too
It’s not just these three known unknowns of retirement that could affect your finances, either. Other variables outside of your control might affect your income needs too, from emergency repairs to your home to care costs later in life.
When creating a retirement plan, adding a buffer and carrying out regular reviews could help you manage your finances and feel confident about the future.
Get in touch to talk about creating a sustainable retirement income
Contact us to talk about your retirement plans and how you might manage financial variables, including known unknowns. A retirement plan could give you confidence in your finances and mean you can focus on enjoying the next chapter of your life.
Please note: This blog is for general information only and does not constitute financial advice, which should be based on your individual circumstances. The information is aimed at retail clients only.
A pension is a long-term investment not normally accessible until 55 (57 from April 2028). The fund value may fluctuate and can go down, which would have an impact on the level of pension benefits available. Past performance is not a reliable indicator of future performance.
The tax implications of pension withdrawals will be based on your individual circumstances. Thresholds, percentage rates, and tax legislation may change in subsequent Finance Acts.