By Dale Critchley, Workplace Policy Manager, Aviva
I am not too many years away from retirement, and a few questions immediately came to my mind.
What difference does this make to the amount I need to save?
The good news is that higher inflation means higher interest rates, higher gilt yields, and a lower cost of a guaranteed income in retirement. Someone aged 65 can currently exchange a £100,000 pension pot for a guaranteed income of around £6,200 per year.
This has put annuities back into the mix when considering retirement options.
The problem comes if I want to achieve the retirement living standard the year after I retire. The revised standards have reminded me that I need to build in some inflation protection. Adding 3% inflation protection takes the annuity income per £100,000 pension pot down to nearer £4,200 . per year. It means I would need a fund of £147,600 to provide an increasing annuity starting at £6,200.
The other problem is that I do not have a crystal ball which predicts future inflation, interest, or annuity rates over my retirement years.
Is drawdown the answer?
If I take the same percentage of my fund as drawdown income each year, and the fund grows by more than inflation, I should have an increasing income each year. However, I do not know what sustainable growth looks like. I understand that if markets fall, and I keep taking income, I will erode my fund through ‘pound cost ravaging’. Selling investments for income when prices are low, leaving less for the future. Also, it is difficult to know the best investments and how long I will need my pot to last.
How much income will I need?
One important consideration is whether I need an income that keeps pace with inflation or, accept a lower income each year as the buying power is eroded by inflation. I can imagine that at some point far in the future I will probably be spending less than in early retirement. However, it is difficult to predict how much less and from what age. Thinking all the way back to my 20s, I had a different view then of what I would be doing now, in my 50s. I want to avoid making the same mistakes now by trying to predict what life in my 70s or 80s might be like.
How do I get the income I need with my pensions?
I am reasonably typical of people my age in having a few different pensions; a small legacy defined benefit pension and a mixture of defined contribution pensions. I need those pension pots to give me what I need, while also protecting against the unknowns created by future inflation or life events.
Are multi-pots the answer?
I’m beginning to think about pensions as different pots, doing different jobs. State pension and defined benefit pensions provide the underpinnings. The drawdown pot provides the income to top up to a target. However, I will still need a rainy-day fund, which might double up as a safety net if inflation exceeds my expectations or markets take a tumble. As for a guaranteed income, that will probably appeal more as I get older and can accept a flat rate of income, and annuity rates reflect reduced longevity.
Like many of us, I try to avoid thinking about the retirement choices I will need to make one day soon. By asking these questions, I have realised that I probably cannot make these choices alone. Fortunately, the pensions industry is now beginning to consider packaged solutions, which will help with the decision making and ongoing management process. Advice, and guidance, are likely to play a key role too. I am also now comfortable with the idea that there is no bullet-proof plan for my retirement income. However, having one that might not go pop with the impact of inflation would be nice.
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