Pensions Planning: The NUMBER

SimonSeys

michaels said:

Secret2ndAccount said:

michaels said: 

I don't think the top chart is adjusted for inflation so pretty meaningless?

The top chart is a chart of inflation: Wage Inflation. If your income merely tracked CPIH you could be reassured that you could continue to afford the food and lodging that you used to buy 20 years ago. Meanwhile your neighbour, tracking the top chart would have an iPhone, Netflix and air conditioning. Over the duration of a retirement, you can fall behind if you only track price inflation. Perhaps use CPIH for your baseline needs, then wages for your discretionary spend. Or accept that your discretionary spend will decrease vs the population over time, which is how many people expect their plan to progress anyway.
State Pensioners receive the higher of price inflation and wage inflation each year.

This very long thread is based on the the premise is that there is a real terms amount per year for life that someone would want to allow them to retire.  Not sure if challenging that concept after 280 pages is that helpful - perhaps this discussion needs its own thread? 

Also whilst in theory there are numerous products that support getting a real terms return I am not aware of any that offer to match average wages increase inflation and all the SWR type models are again about amounts that are maintained in real terms not that keep up with wage inflation.

So I agree with that bit about real terms.  The debate is about which inflation rate to use when calculating real terms.  CPI is relevant for some circumstances.  BCIS-TPI for construction.  I quite like wage inflation for The Number. .  

michaels

But if you stray from cpi/rpi then you immediately leave behind all the literature on SWRs etc plus all the inflation protection products such as index linked annuities, DB pension etc. 

Plus you have to decide what the relationship will be between your new preferred 'real annual increment' and cpi inflation will be - you only need to look at the period since 2008 to see that the relationship between price and wage inflation is in no way fixed.  And how on earth to you guarantee those cash flows - perhaps an index linked gilt ladder with bigger (in real terms) pay outs in each future period but that will be expensive - perhaps you can reengineer the SWR models to give  real terms increasing cash flow? (any simple arithmetical model does not realistically cover SORR, Monte Carlo is perhaps the best approach but a simple historical success rate is what is normally used).

Whereas the number is (in my opinion) an amount that you need per year for the lifestyle you desire and is thus only impacted by changes to the price index which then allows you to calculate the NUMBER - what size pot you need to save to provide the number annually for your modelled life expectancy.

Tomorrow I might just work out the pot sizes needed for 35k pa flat in real terms with an SWR of 3.5% for 40 years vs 35k rising in real terms by 0.5% pa and 1% pa.

hugheskevi

Escalation of a target annual income is an interesting topic. Some of the obvious options would be CPI, RPI, and average earnings.

Escalating by average earnings maintains your income relative to wider society, although it might be necessary to consider taxes, especially during fiscal drag and so work from net income rather than gross income. That is important for those doing calculations earlier in life, and especially those retiring very early. This is most clearly demonstrated by comparing target income to minimum wage, and seeing how this will change over time. Minimum wage should increase in line with average earnings, which are expected to be about 1.8 percentage points higher than CPI. So someone retiring on a target income of double the minimum wage would find themselves living on only 1.5 times minimum wage after 17 years. If that person had retired at age 50, they are likely to perceive their standard of living deteriorating significantly over time.

However, earnings escalation throughout the whole of retirement is probably excessive. That would leave retirees with more and more income as their needs decline, and they would have their highest income on their deathbed.

RPI is a possible halfway house, with an expected rate of about CPI+1%. But that is probably irrelevant given the series will be discontinued in 5 years.

Personally I decided that targeting escalation equal to earnings to age 68 and then by CPI thereafter was a balance I was happy with. The best way to achieve that via investments is a different matter.

LL_USS

Hi everyone,

Could you please help by adding the information of whether the NUMBER you mention is gross or net. For e.g. 2/3 current income for retirement that @gmje mentioned, is that after tax or gross? Or the "35K/year flat in real term" mentioned by @michaels is it before or after tax? Thank you :-)

kimwp

LL_USS said:

Hi everyone,

Could you please help by adding the information of whether the NUMBER you mention is gross or net. For e.g. 2/3 current income for retirement that @gmje mentioned, is that after tax or gross? Or the "35K/year flat in real term" mentioned by @michaels is it before or after tax? Thank you :-)

Is the number not your outgoings? In which case gross and net are irrelevant?

michaels

hugheskevi said:

Escalation of a target annual income is an interesting topic. Some of the obvious options would be CPI, RPI, and average earnings.

Escalating by average earnings maintains your income relative to wider society, although it might be necessary to consider taxes, especially during fiscal drag and so work from net income rather than gross income. That is important for those doing calculations earlier in life, and especially those retiring very early. This is most clearly demonstrated by comparing target income to minimum wage, and seeing how this will change over time. Minimum wage should increase in line with average earnings, which are expected to be about 1.8 percentage points higher than CPI. So someone retiring on a target income of double the minimum wage would find themselves living on only 1.5 times minimum wage after 17 years. If that person had retired at age 50, they are likely to perceive their standard of living deteriorating significantly over time.

However, earnings escalation throughout the whole of retirement is probably excessive. That would leave retirees with more and more income as their needs decline, and they would have their highest income on their deathbed.

RPI is a possible halfway house, with an expected rate of about CPI+1%. But that is probably irrelevant given the series will be discontinued in 5 years.

Personally I decided that targeting escalation equal to earnings to age 68 and then by CPI thereafter was a balance I was happy with. The best way to achieve that via investments is a different matter.

So anyone who is targeting earnings, what figure are you using as your real terms increase as the increase in real earnings has bene somewhat variable over the years and recently much lower (perhaps due to a mature economy and aging population?)

Also how do you link it with any of the SWR analysis that is all based on a constant inflation adjuested income?

hugheskevi

michaels said:

hugheskevi said:

Escalation of a target annual income is an interesting topic. Some of the obvious options would be CPI, RPI, and average earnings.

Escalating by average earnings maintains your income relative to wider society, although it might be necessary to consider taxes, especially during fiscal drag and so work from net income rather than gross income. That is important for those doing calculations earlier in life, and especially those retiring very early. This is most clearly demonstrated by comparing target income to minimum wage, and seeing how this will change over time. Minimum wage should increase in line with average earnings, which are expected to be about 1.8 percentage points higher than CPI. So someone retiring on a target income of double the minimum wage would find themselves living on only 1.5 times minimum wage after 17 years. If that person had retired at age 50, they are likely to perceive their standard of living deteriorating significantly over time.

However, earnings escalation throughout the whole of retirement is probably excessive. That would leave retirees with more and more income as their needs decline, and they would have their highest income on their deathbed.

RPI is a possible halfway house, with an expected rate of about CPI+1%. But that is probably irrelevant given the series will be discontinued in 5 years.

Personally I decided that targeting escalation equal to earnings to age 68 and then by CPI thereafter was a balance I was happy with. The best way to achieve that via investments is a different matter.

So anyone who is targeting earnings, what figure are you using as your real terms increase as the increase in real earnings has bene somewhat variable over the years and recently much lower (perhaps due to a mature economy and aging population?)

Also how do you link it with any of the SWR analysis that is all based on a constant inflation adjuested income?

I think OBR forecasts, which are updated at each Budget, are about as good as anything. Hopefully short-term volaility will even itself out over the medium or long-run. Constantly updating assumptions will also adjust to short term volatility.

Existing income needs plus future escalation then forms the future cashflow requirement for each future year. That will also take into account things like DB income, State Pension, triple lock, etc. Which in turn determines the investment strategy and withdrawal, based around expected returns, volatility, risk-reduction, etc. Which is probably easier said than done.

michaels

hugheskevi said:

michaels said:

hugheskevi said:

Escalation of a target annual income is an interesting topic. Some of the obvious options would be CPI, RPI, and average earnings.

Escalating by average earnings maintains your income relative to wider society, although it might be necessary to consider taxes, especially during fiscal drag and so work from net income rather than gross income. That is important for those doing calculations earlier in life, and especially those retiring very early. This is most clearly demonstrated by comparing target income to minimum wage, and seeing how this will change over time. Minimum wage should increase in line with average earnings, which are expected to be about 1.8 percentage points higher than CPI. So someone retiring on a target income of double the minimum wage would find themselves living on only 1.5 times minimum wage after 17 years. If that person had retired at age 50, they are likely to perceive their standard of living deteriorating significantly over time.

However, earnings escalation throughout the whole of retirement is probably excessive. That would leave retirees with more and more income as their needs decline, and they would have their highest income on their deathbed.

RPI is a possible halfway house, with an expected rate of about CPI+1%. But that is probably irrelevant given the series will be discontinued in 5 years.

Personally I decided that targeting escalation equal to earnings to age 68 and then by CPI thereafter was a balance I was happy with. The best way to achieve that via investments is a different matter.

So anyone who is targeting earnings, what figure are you using as your real terms increase as the increase in real earnings has bene somewhat variable over the years and recently much lower (perhaps due to a mature economy and aging population?)

Also how do you link it with any of the SWR analysis that is all based on a constant inflation adjuested income?

I think OBR forecasts, which are updated at each Budget, are about as good as anything. Hopefully short-term volaility will even itself out over the medium or long-run. Constantly updating assumptions will also adjust to short term volatility.

Existing income needs plus future escalation then forms the future cashflow requirement for each future year. That will also take into account things like DB income, State Pension, triple lock, etc. Which in turn determines the investment strategy and withdrawal, based around expected returns, volatility, risk-reduction, etc. Which is probably easier said than done.

Do you apply the historic period analysis of the SWR work to your unequal cashflows or apply a monte carlo technique?  I think any sort of linear trend approach is of limited value given the volatility / sorr that we know exists.

hugheskevi

michaels said:

hugheskevi said:

michaels said:

hugheskevi said:

Escalation of a target annual income is an interesting topic. Some of the obvious options would be CPI, RPI, and average earnings.

Escalating by average earnings maintains your income relative to wider society, although it might be necessary to consider taxes, especially during fiscal drag and so work from net income rather than gross income. That is important for those doing calculations earlier in life, and especially those retiring very early. This is most clearly demonstrated by comparing target income to minimum wage, and seeing how this will change over time. Minimum wage should increase in line with average earnings, which are expected to be about 1.8 percentage points higher than CPI. So someone retiring on a target income of double the minimum wage would find themselves living on only 1.5 times minimum wage after 17 years. If that person had retired at age 50, they are likely to perceive their standard of living deteriorating significantly over time.

However, earnings escalation throughout the whole of retirement is probably excessive. That would leave retirees with more and more income as their needs decline, and they would have their highest income on their deathbed.

RPI is a possible halfway house, with an expected rate of about CPI+1%. But that is probably irrelevant given the series will be discontinued in 5 years.

Personally I decided that targeting escalation equal to earnings to age 68 and then by CPI thereafter was a balance I was happy with. The best way to achieve that via investments is a different matter.

So anyone who is targeting earnings, what figure are you using as your real terms increase as the increase in real earnings has bene somewhat variable over the years and recently much lower (perhaps due to a mature economy and aging population?)

Also how do you link it with any of the SWR analysis that is all based on a constant inflation adjuested income?

I think OBR forecasts, which are updated at each Budget, are about as good as anything. Hopefully short-term volaility will even itself out over the medium or long-run. Constantly updating assumptions will also adjust to short term volatility.

Existing income needs plus future escalation then forms the future cashflow requirement for each future year. That will also take into account things like DB income, State Pension, triple lock, etc. Which in turn determines the investment strategy and withdrawal, based around expected returns, volatility, risk-reduction, etc. Which is probably easier said than done.

Do you apply the historic period analysis of the SWR work to your unequal cashflows or apply a monte carlo technique?  I think any sort of linear trend approach is of limited value given the volatility / sorr that we know exists.

Monte Carlo with a comprehensive set of economic scenarios would be the ideal approach, although you still have to decide risk tolerance and obtaining this outside a commercial setting will probably be difficult. I think some pension providers have offered this as a tool at some times though. cFiresim and such-like are also useful, albeit backward-looking.

Risk tolerance is likely to have a step-change at point of full retirement. Until that point investment risk can be significantly mitigated by working longer. Even so, a wholesale change of portfolio is unlikely if funds will be needed for a long period, eg, full retirement. But if funds are predominantly needed for a short term, eg, to smooth income to State Pension age, then a more significant change might be sensible.

I think any type of linear trend approach will only work if using noticeably lower risk investments. Even then, the bond experience of the last 5 years shows this cannot be relied upon. Recent analysis of outcomes under lifestyling has shown that it has pretty much always cost members money, as the protection it has provided at times is outweighed by the lost returns in the rest of the period. So in practice this is probably only relevant to periods of short-term income provision, eg, smoothing income to State Pension age, when investments might have a large cash and defensive composition.

NoMore

I think this thread has gone off the rails a bit, its not about drawdown strategies, its about the initial income you expect to require in retirement.

How to achieve that and what strategy to inflation proof this is a whole different subject. I'm surprised there isn't a pinned thread to discuss this very thing, it does tend to come up often.