Pension calculation help to get me to 25k pa

FatherAbraham

It_Aches wrote: »

Would really appreciate guidance on what is needed in terms of future investment by me to get me from my current position to my goal of circa 25k pa pension excluding state pensions.

My wife and I spent yesterday looking at our spending patterns and determined - in todays money - that in order not to impact lifestyle too significantly we would need 25k pa after tax in retirement.

You also need to consider how much income each of you would need as a minimum when the other has died. This may be the costliest part of the pension purchase.

The most income that you pension pot can buy for your wife will be a 100% survivor pension in your name. That'll be expensive.

It might be easier to reach your post-retirement income-insurance goals by her having a pension pot of her own. Each of you can then buy a mix of sole incomes and joint-life incomes to hit the right numbers.

Non-tax-paying wife, lower-paid dream job, retirement age of 60, and £25,000 a year pension income? Something's got to give.

Warmest regards,
FA

AlwaysLearnin

FatherAbraham wrote: »

The most income that you pension pot can buy for your wife will be a 100% survivor pension in your name. That'll be expensive.

That's a big benefit of income drawdown over annuity, as the pot is transferable on death.

cynicalgit_2

Remember that you'll be able to withdraw 25% as cash tax free.
100k is a tidy sum to have for all the luxuries you may want.
Don't forget that you're outgoings will be a lot less as you get older.
It's good to be planning now, wish I had!!

It_Aches

Dunroamin wrote: »

Wouldn't your wife becoming a tax payer by working be the best thing for her pension?

Actually for brevity I glossed over my wife's contribution - she does work - she is self employed in the social services arena but her earnings have never and probably will never be high enough to pay tax and it can be intermittent work. I see the mistake we've made though which was to treat her earnings as simply supplemental to other things we have been working toward - that will now change and pension provision for my wife will be the driver.

It_Aches

Loughton_Monkey wrote: »

Personally, I would come at it from a totally different angle. It's your own words "not to impact lifestyle too significantly" which are, to me, the red flag.

As a deliberate early retiree, I started my own working life rather less 'aware' than you are now, but did simply bang away a load of money on the basis of it being a 'good thing'.

But at roughly your own age I attacked it a different way. Although I wanted to retire 'early', I posed the question "How much can I spend to ensure that when I retire, I can continue to spend the same. Inflation provided."

[*Note that the word 'same' was my own deliberate choice. It could well have been spending more, or less, depending upon what I chose to do in retirement, but for me, the ratio of work spending to retrement spending came to 1:1 It really needs thinking through in some detail - what you want]

I recognised the truths that:

(a) It is spending and not 'saving' which is the 'active verb'. OK, what we don't spend is, by definition, saved. But believe me by focussing on spending rather than saving, you will achieve a far, far, better plan.

(b) At the end of the day, when we say 'lifestyle' we normally mean 'spending money'. So that's what to focus on. By keeping accurate accounts on where the money goes, it is not difficult to envisage your 'desires' in retirement, and calculate the price tag. It is normally similar to what you spend now, but just on a different mixture of things. And,

(c) To pose the question the way you have done gives you a dilemma. In your mind, you have a 'fixed' retirement date and want a fixed amount of income then. Although that's what I started doing, I soon realised that by focussing on spending and posing the question as I did, it allowed me simply to model my income and spending going forward, and spreadsheets are so powerful you can simply 'cut' that income at any time and see how it pans out. So your retirement date becomes an extra 'variable'.

Like me, you probably do not know whether you will have 'had enough' by 55, or 60, or whether you are the type to work happily until 70. But if you use the approach I have outlined, and 'fine tune' your spending [and thus saving] to [finger in the air] age 61, say, then there is a strong prospect you can achieve that. If things get a bit wobbly, then no matter, you can either adjust spending, or move out your retirement date.

My suggested approach takes a bit of time initially, and some interesting spreadsheet work, but boy it did me proud. I had aimed to retire at 55, and achieved it 5 months into age 56. My spreadsheet of income and spending developed (as did the assumptions) right up to the day I retired. Since then, I still use those figures and run my finances according to them. There have been swings and roundabouts, but after almost 8 years of retirement, I have built up a 'contingency fund' despite living just the lifestyle I wanted. I want (financially) for nothing more.

This is fascinating LM, I'm very grateful you took the time to respond. You hit the nail on the gead generally I think - that this is as much a mental game as it is anything else - and that if I can take the time to frame the issue carefully then after that I can look at it from all different and unexpected angles. I like your approach of a spend focus bias rather than a save bias and will talk it through with my wife. Thanks again.

It_Aches

FatherAbraham wrote: »

Yes, I agree -- there's a strong tax case for using the untaxed wife's tax-relieved contribs in preference to his own. Income saved in a pension for the wife will get an effective tax rate of 0%, until her tax-free income limit is reached. Putting the same income into his own pension gives an effective tax rate of 15%.

Low-earning wives are an expensive luxury for many couples these days.

Taking a low-paid, dream job at 44 is also an expensive luxury for many of us.

Warmest regards,
FA

patanne and Father Abraham - thanks for this and one of the themes I'm taking from this whole thread is that I have been very lax regarding pension provision in my wife's name - hopefully it's a lesson learned still with enough time to do something about it - so no further AVCs for me until we have something in place for my wife.

Father Abraham - "Taking a low-paid, dream job at 44 is also an expensive luxury for many of us" - Yes indeed - and if nothing else then this thread has confirmed that it is also a dream only for me.

To clarify however - my driver was not to take some irresponsibly low earning dream job, I have no specific job in mind - my driver is more about finding a job that I see real value in and perhaps enjoy just a little but that still pays well hopefully...and being able to finally turn my back on a role with a corporate giant that pays very well but dominates my life. I was simply therefore testing the reality of the situation should I find the guts to do that and shed the golden handcuffs.

jamesd

It_Aches wrote: »

Spotted any errors?

A bug in the calculator described below. I don't know if it affected your calculation, but watch out for it.

It_Aches wrote: »

I guess I'm shocked at the answer

You should be shocked at the answer. It illustrates just how poor a choice it would be to use an annuity to buy all of your retirement income.

But before looking at annuity alternatives, the assumptions used in the calculator are:

1. Growth rate before charges and inflation of 7%, charges of 1% and inflation of 2.5%, so actual growth rate assumed to be just 3.5%. The actual return of the UK main stock market over the last hundred plus years has been 5.2% plus inflation and it's easy to get tracker funds for 0.2% or so.
2. Income is assumed to come from an inflation-linked annuity. Around 90% of people buy level annuities, with no inflation linking.
3. An annuity with spousal income provision is used.

To allow for the property value just put that number in now and assume that property values increase with inflation. I've added £50,000 to the current pot value of £192,000 for this to get to a starting pot value of £242,000, I used a male born on 6 April 1969 for the calculations.

Using the default values the answers are:

Age 65: £477,293 pot, £21,067 annuity income at 65 with no more contributions. 84% of target. Need to add £251 of "employer" (after tax relief) contribution a month to reach the target with pot size of £566,432. Annuity rate 4.4%.
Age 60: £406,036 pot, £15,806 income, 63% of target. Add £960 a month to reach the target, with pot size then of £643,992. Annuity rate 3.9%.
Age 55: £345,400 pot, £12,093 income, 48% of target. Add £2340 a month to reach the target, with a pot size then of £711,542. Annuity rate 3.5%.

First thing to notice there is that the pot size it takes gets much bigger as you get younger because annuity prices go up as you get younger.

On to how to change the results to something more sensible. Step one is to use normal historic returns, not the rigged low ones used in the calculator. To do that I used advanced options and changed the estimated growth to 9% and the annual management charge to 0.5%. That gets close to the historic return of 5% plus inflation after a 0.2% management charge. The new numbers are:

Age 65: £782,128 pot, income £43,901, 176% of target.
Age 60: £591,531 pot, income £30,221, 121% of target.
Age 55: £447,380 pot, income £21,194, 85% of target. £450 a month to get to the target income, pot size £528,449, income £25,034.

It's clear that the calculator is not working correctly. In the first calculation it took a pension pot size of £711,542 to get the target income at 55, this time around it says it only takes £528,449. I didn't change any annuity options so there's some breakage in the calculation because annuities don't get cheaper or more expensive when the growth rates to get to the pot size change.

I've reported the bug to HL and maybe they will fix it. In the meantime, beware. If you change the investment assumptions, the annuity rate used may change even for the same pot size.

I'll continue using the original annuity rates and target pot sizes but the historic growth rates. Just remember that you can't trust the projected income this time, it's the same £25,000 throughout in spite of what the calculator says:

Age 65: pot £782,128. Over the required pot size of £566,432 with 4.4% annuity rate so no more contributions needed. At 4.4% annuity rate income would be £34,413.
Age 60: pot £591,531. Add £170 a month to get to pot size of £643,591 and hit the target at an annuity rate of 3.9%.
Age 55: Pot 447,380. Add £1465 a month to get to pot size of £711,305 and hit the target with 3.5% annuity rate.

So, adjusting to historic returns rather than the ones used in the calculator gets these changes in contributions:

Age 65: £251 a month drops to nothing and over target already.
Age 60: £960 a month drops to £170 a month.
Age 55: £2,340 a month drops to £1,465 a month.

So, that's with the annuity purchase option. But there is an alternative, the same one used in most countries: income drawdown. I'll cover that in a second post.

jamesd

So, the requirement to buy a lifetime annuity with pension pots was abolished in 2006 when Alternatively Secured Pensions were introduced for those aged 75 and over, today those are just standard drawdown pensions after some more changes.

An income drawdown income has a range of advantages and disadvantages to consider but here are the most significant ones:

1. It provides a 100% spousal pension with no drop in original income. A spouse gets to inherit the pot into a pension pot of their own with no tax charge. Anyone else or a spouse can get it outside a pension pot after a 55% tax charge.
2. The income is not guaranteed by an annuity provider. You must allow for investment value variations in your planning.
3. The price of buying an income doesn't change much as you get older or younger because investment returns don't change with your age but the markets. There's some variation because the rate at which you can draw on capital goes down as you get younger, else you risk major income drop out in a long life case, though not actual running out of money because the GAD limit rules tend to make that effectively impossible
4. If you do not live to the latest age used in your income planning the capital left over can be inherited. With a standard annuity it's spent at the outset and whether you live a short or ling time you still don't get it back for inheritance.

So, what about income levels? Something between 5% and 6% is reasonable for rough planning if you're content to drain all of the capital if you live a very long life, to say age 110. I'll use 6% for age 65, 5.5% for age 60 and 5% for age 55 just to get started, then cover a more sophisticated approach in a later post. Here's how those calculations go, using the HL calculator to work out what to pay in to get the target pot size I give:

Age 65: 6% for £25,000 income requires £25,000 / 0.06 = £416,666 pot. Already going to get there with the current pot size and historic returns, no more needed.
Age 60: 5.5% for income requires £25,000 / 0.055 = £454,545 pot. Already there with historic returns, no more needed.
Age 55: 5% for income requites £25,000 / 0.05 = £500,000 pot. Add £300 a month to get to this.

At this point you can see some of why drawdown is attractive compared to current annuity rates and why it's even more attractive at younger ages. It's relatively easy to get to the point of retiring at 55.

But what about investment risk?

The answer to that is:

1. Use a generous safety margin. For very rough planning I tend to add 50-100% to targets. If the worst case - a big market drop just after retirement - doesn't happen you get the extra income to use, if it does, you still hit your target.
2. Keep a cash reserve of one to five years of investment income in savings or very low risk investments plus a year in savings. This is your cushion against having to draw on capital during a market downturn as well as against things like changes in the law. A recent US paper found a significant increase in drawdown success rate from just one year in cash.
3. Be willing to adjust your income. In practice we tend not to have rigid targets but instead have minimum , good to have and nice to have sorts of ranges. If you want to retire earlier, you can decide that you will accept some drop in income if the bad cases happen to get that early retirement chance. Or you can retire later and get higher safety margins if you prefer that. Your choice, pick whichever you like.

But there's a more refined answer: back testing with historic market variations to see what would have happened in a range of market conditions. On to Firecalc in the next post.

jamesd

So, Firecalc. Take a look and see the graph of the different outcomes for three people who just retire at different times with the same pot size? That's investment risk for you and it's what you have to plan for and manage. This is a US tool with US investment returns but it's still a good way to look at risk and how to plan for it.

Lets use it to take a quick look at your situation. Put in 25,000 spending, the age 55 pot size of $500,000 (just pretend dollars are Pounds) and 45 years, assuming you live to 100. Click on Submit: "FIRECalc found that 45 cycles failed, for a success rate of 54.1%" and you can see a graph showing all 98 of the historic investment periods it used in the testing.

Now, I don't like a 54% success rate, what does it think the income could have been for 95% success rate? Close the results window and click on Investigate at the top. Near the bottom there's a button for "Given a success rate, determine the ... portfolio for a set spending level. Put 95% into the success rate and click on the Starting portfolio value button, then click on Submit.

"A starting portfolio of $696,462 provided a success rate of 95.9% (98 total cycles, of which 4 failed)."

Want 99%? Close the results window, change to that and clock Submit: "A starting portfolio of $771,753 provided a success rate of 100.0% (98 total cycles, of which 0 failed)."

Or try the $500 initial value and use the income calculation: "A spending level of $16,196 provided a success rate of 100.0% (98 total cycles, of which 0 failed)"

There are plenty of other options, including those which vary income if the markets do badly. Close the results window, change the Investigate option back to the first choice "The success rate of..." and click on Submit, then close the result window and click on Spending Models. Choose Percentage of Remaining Portfolio and set the percentage to 75%. Have a look at how you had to adjust spending downwards to make it. You can see the lowest level is around $/£9,000.

That's not good enough for me so I'd increase the target pension pot size to reduce the chance of failure.

But also look at the graph and see why those cases fail. The common factor is a big drop in pot values due to a market downturn just after retiring. You can do things about that. The cash reserve is one. Another is buying options or covered warrants just before retiring, to protect yourself if those things happen. Yet another is being willing to delay retiring if it happens to be a bad time when you want to retire.

With this sort of planning you get flexibility to control your own balance between age of retirement and what level of flexibility you want on income level. How much reduction in income if you get unlucky are you willing to take to retire say five years earlier?

Now, as always with risk I've looked at the bad cases. The charts and numbers also show the good and normal cases. You get a higher income if those happen. With the annuity route you don't, you lock yourself into something close to the bad case income level.

Don't go over the top with Firecalc, it is US data after all. But it is a good tool to show you that averages are not sufficient for risk management. You need to be aware of and consider variation of returns if you want to do a really decent planning job.

And for now I'll stop there on this track. Plenty to think about and perhaps explore.

Whiteflag

mgdavid wrote: »

why does one need an IFA to do simple arithmetic?

Where did my post mention an IFA?

I got the impression understood what the op is looking for is a lot more than a few simple calculations