In the last blog we discussed people living longer and how likely those living in the western world are to live to age 100 or more. We also started to explore the first area for discussion when we consider ‘What happens if I live until I am 100’ and specifically how much money you will need in retirement.
In this post, we will continue to explore the pension gap in more detail, including how to bridge this with alternative income streams.
I’ll explain the gap by way of example as it’s the easiest way to demonstrate this.
PLEASE NOTE THAT THIS IS FOR ILLUSTRATIVE PURPOSES ONLY AND DOES NOT FACTOR IN ANY TAX IMPLICATIONS, ALLOWANCES, OTHER INCOME STREAMS. NOR DOES IT REPRESENT ANY ADVICE STRUCTURE.
Adam & Eve want to retire aged 67 when they will be eligible for the State Pension. Both are expected to have a full record of NI contributions and should receive the full State Pension of £9,339 per annum (today’s money). They would like a comfortable retirement for which they envisage a need of £47,500 per annum between them. They have the following pensions with the valuations below: -
The broad-brush approach shows that they need a combined pot in the region of £1,187,500 (£47,500 x 25 years).
Currently, their schemes have a value of £540,000 and using the same 25 year principle provides £21,600 per annum, meaning when coupled with their State Pensions, the GAP (roughly speaking) is £7,222 per annum, or £181,000 (over 25 years).
This gap could be filled in many ways through additional pension contributions which carry tax advantages or could be provided through other income streams as we covered in Blog no.2
What’s key though in understanding the gap, is the implications of not filling it. What would be the impact if you were to run out of funds in retirement? Is there a back-up plan? What would you need to give up to enable your funds to last? What if you planned to live a further 25 years, and achieved Centenarian status or older? Who knows what the future holds.
Things to consider when looking at bridging the gap and that highlight the need TO SEEK EXPERT ADVICE before doing anything are:
Are your pension schemes invested with a lifestyle strategy? How may this impact your pensions?
Do you understand what actual risk profile your existing funds are invested in and what level of return these are generating for you?
Do you have Defined Benefit or Defined Contribution schemes, and are you aware of the differences between these and the flexibility offered by the latter in how you can access your funds in retirement?
Your current income and tax position, and what benefits there may be from making additional contributions via salary sacrifice.
How best to utilise your annual allowance re pension contributions and does your employment income level impact this at all.
Using savings to make lump sum or regular contributions to a personal pension and what this means from a tax perspective.
Taking money from your investments may give rise to gains and with that a tax liability.
ISAs are a useful way of creating future income streams as they are very tax efficient, and flexible.
Income from properties will need to be reported via your self-assessment and, as such, is taxable.
Downsizing your property will incur charges for the sale and may impact any future estate calculations and available allowances when assessing your estate for inheritance tax purposes.
You should always understand the implications of making decisions, particularly where tax is concerned. This guide provides some insights to help demystify tax jargon.
None of the above should be taken lightly, and equally should never be left until it’s too late. Time is the most precious commodity we have, and the longer we have to work towards our goals, the lower the cost impact, and the greater potential benefit we can achieve via compounding, which Einstein called “The eighth wonder of the World”.
Seeking advice shouldn’t be seen as something you do in later life, nor should it be seen as only available to the wealthy.
The next stage in the process and final point for this blog post, is to create a plan. There is no point working out how you will fill the gap, unless you have an idea of what income you will need, when you’ll need it, and what events/goals you will be realising that may cause spikes in the timing of your income needs. Understanding the art of the possible allows you to focus the mind on what is realistic, so you can use time wisely in the journey from A to B, to make sensible financial decisions along the way.
A good Financial Adviser should always look to do this as a way of truly understanding their client’s needs in the short, medium and long term.
This concludes the third in our Blog series. In the next post, we will explore health and what should be considered, and the implications of living a long life.