contributions and pot required to retire at 55 with stable income

marathonic

grey_gym_sock wrote: »

using the 25% lump sum to help boost income in the period before state pension starts is a good idea.

but it's too rigid to insist on providing 100% equivalent of the state pension by this means. because that forces you to accumulate 4 x the amount required inside a pension, which may be more than you need, depending on your other targets and assumptions.

alternatively, you could use a mixture of the lump sum and S&S ISAs to cover this period.

I agree with this. I just done the figures out of interest.

My own personal plan is to aim for retiring at 55 using optimistic growth figures and, should the estimated growth not transpire, the flexibility comes in being able to push retirement age out to 60-65.

jamesd

marathonic wrote: »

I think you are missing my point that my figures are what is required to use your 25% tax-free lump sum to sustain an income equal to the state pension from the age of 55 until a retirement age of 70.

I didn't miss that. I thought it was interesting and useful.

It's the sort of planning I do as well. A mixture of pension and ISA for me, though I'm now getting 58.9% income tax and NI relief on some pension money and that part is looking more attractive than ISA now even with the GAD limit. Less than that on most of it,though. I might even end up not using my ISA allowance or withdrawing money from ISAs.

marathonic wrote: »

Using your £254 figure for 35 years at 5% growth after inflation, I come up with a pot of £288,567.48.

£254 net is what it takes to get to £445,000 with 5% growth rate, basic rate tax relief and the employer matching using 2018 auto-enrolment rules for a person on average income. Since that's mandatory for an employer it's what we can expect anyone to be able to get as a minimum from then.

Your gross calculation with reduced growth rate is OK for those who follow what you did but it's the sort of number that would scare people unnecessarily if they didn't know what you did. So I did calculations with some likely employer matching and tax relief to show a more likely net cost.

marathonic wrote: »

Basically, my figures would see someone using their 25% tax-free lump sum to withdraw £7,488 in todays money, increasing with inflation between the age of 55 and 70. It assumes a growth rate 1% in excess of inflation - as you wouldn't be invested in the riskier assets at that point.

Here are the historic after inflation returns for various UK investments from the 2011 Barclays Equity Gilt Study, page 92:

Equities: 5.1%
Gilts: 1.2%
Corporate bonds: 2.1% (only over 10 years)
Index-linked bonds: 4.3% (only over 20 years)
Cash: 1.0%

So 1% was effectively saying that a person who has been happy investing for decades is going to stop investing and just use cash from the day they retire at 55 even though they know that an average life expectancy will mean living another 35+ years.

I just don't expect experienced investors to go into 100% cash for 35 years unless they have a huge surplus pot size and no interest in providing an inheritance either.

marathonic

jamesd wrote: »

Your gross calculation with reduced growth rate is OK for those who follow what you did but it's the sort of number that would scare people unnecessarily if they didn't know what you did. So I did calculations with some likely employer matching and tax relief to show a more likely net cost.

That's a very good point and, on that basis, I totally agree with you!

Linton

James figures are useful as they provide a real possibility. However in planning ones future I think one should be careful of using "average" figures as they have a 50% chance of being over optimistic, even if the average in the future is as good as the average in the past which is far from certain.

Conversely one should avoid being scared by over-pessimistic figures. A sensible approach in my view is to start off on fairly pessimistic assumptions, perhaps having a later retirement date than ideal rather than paying in more than one can afford. After a few years one can plan again on the pessimistic assumptions and if performance has actually been better one should see retirement date moving forward. Under those circumstances you have a life of continuous pleasant surprises rather than deepening depression.

Tancred

marathonic wrote: »

Working out these figures was more an academic excercise for me as opposed to my actual pension planning.

However, the results are pretty interesting. The subject is: 'Someone who wants to retire at 55 and take an annuity that rises with inflation whilst using their 25% Tax Free Lump sum to give them the same income as the £144 state pension per week until they reach 70 (probably the state pension age when I get there).'

The assumption is that the tax free lump sum is invested in a product that provides a return of 1% over inflation - which should be a relatively low-risk product given the expected return. The 25% lump sum capital is to be entirely depleted by the persons 70th birthday.

The theory is that someone could use these assumptions to come up with a smooth income after retirement - no jump in income when they reach state pension age.

From age 55, with a return of 1% in excess of inflation, a pot of £111,285 would be entirely depleted at age 70 by withdrawing £144 per week (£7,488 annually). To achieve this as a 25% tax-free lump sum would require a pot of £445,140. The withdrawal rate on the initial lump sum pot value is 6.66%.

Therefore, if one were to draw down on the remaining 75% at a rate of 3.33% per year, the pot could sustain an income, including state pension when it comes, of 2.5 times the value of the state pension - or £360 per week.

To achieve a pot, in todays money, of £445,140 by investing at a return of 3% above inflation after charges from the age of 20 to 55 would require monthly contributions of a little over £600 (this also needs to increase with inflation).

This looks like a pretty hefty goal but, if anyone disagrees with the figures, let me know.

Are you aiming to retire at 55 on £144 a week? Do you think you could live on that and pay the bills? I don't see your logic. Why not work an extra 10 years and have much more comfortable income?

Tancred

marathonic wrote: »

Basically, my figures would see someone using their 25% tax-free lump sum to withdraw £7,488 in todays money, increasing with inflation between the age of 55 and 70. It assumes a growth rate 1% in excess of inflation - as you wouldn't be invested in the riskier assets at that point.

By the age of 70, the tax-free lump sum would be depleted. After the age of 70, you are in receipt of the state pension - so your income is contant.

The remaining 75% of your pot could be used for drawdown, an annuity, or however else the rules allow. For example, using the figures in my original post, if it gave an annuity of 3.33%, it would result in an annual income of £11,017.

What about bills? £11k is just about liveable income but you would still need to live very frugally. You would need to have your mortgage paid off etc. Are you confident of having done that by then? Your plan would work a lot better by targeting retirement at 60 - 55 is much too optimistic in my view.

Linton

Tancred wrote: »

What about bills? £11k is just about liveable income but you would still need to live very frugally. You would need to have your mortgage paid off etc. Are you confident of having done that by then? Your plan would work a lot better by targeting retirement at 60 - 55 is much too optimistic in my view.

The plans assume a state pension in addition to the income from personal savings. Although £18K seems a bit low to me its higher than the median income of single pensioners now.

Tancred

sandsy wrote: »

Retiring at 55 means considering a retirement income for around 35 years, as Linton pointed out (life expectancy of 90 roughly).... Which means the person would be in retirement for about the same length of time as their working life, if they started at 20.

What the actuaries say and the real world are two very different things. Many people still die well before 90 but the pensions stop being paid at death, irrespective of whether that is 70 or 100. Actuaries make calculations to cover the backside of insurance companies (and now the government as well), not to meet our best interests.

jamesd

Linton wrote: »

James figures are useful as they provide a real possibility. However in planning ones future I think one should be careful of using "average" figures as they have a 50% chance of being over optimistic, even if the average in the future is as good as the average in the past which is far from certain.

Sort of, but the distribution of results isn't a normal distribution. Most results are more positive but the few really bad ones are quite bad. Most of the extra contribution cost comes to protect against the worst five percent or so of historic results. It's one reason why I like Firecalc because that does a nice job of illustrating the nature of the variability.

Linton wrote: »

Conversely one should avoid being scared by over-pessimistic figures. A sensible approach in my view is to start off on fairly pessimistic assumptions, perhaps having a later retirement date than ideal rather than paying in more than one can afford. After a few years one can plan again on the pessimistic assumptions and if performance has actually been better one should see retirement date moving forward. Under those circumstances you have a life of continuous pleasant surprises rather than deepening depression.

What I tend to prefer to do is use the historic results but then also add explicit safety margins in the 50-100% range. I prefer that because it helps to set correct expectations for the sort of variation that can be expected in the most extreme of the adverse market performances, so I think it's useful education compared to using reduced growth or income rates.

I also tend to like it because it helps to show the significantly higher income that could be expected in the more normal cases. That's of interest when comparing to annuities, where the annuity purchase eliminates the more common upside as well as the downside.

As you suggest, in most cases either way will produce a life of regular pleasant surprises, because the extreme bad cases are quite unlikely.

FatherAbraham

marathonic wrote: »

The assumption is that the tax free lump sum is invested in a product that provides a return of 1% over inflation - which should be a relatively low-risk product given the expected return. The 25% lump sum capital is to be entirely depleted by the persons 70th birthday.

...

Therefore, if one were to draw down on the remaining 75% at a rate of 3.33% per year, the pot could sustain an income, including state pension when it comes, of 2.5 times the value of the state pension - or £360 per week.

To achieve a pot, in todays money, of £445,140 by investing at a return of 3% above inflation after charges from the age of 20 to 55 would require monthly contributions of a little over £600 (this also needs to increase with inflation).

This looks like a pretty hefty goal but, if anyone disagrees with the figures, let me know.

I like the principle of your thinking, but I also think your returns are too high all round.

It would be more prudent to adjust the 1% real return on the invested lump sum to be 0%.

It would be sensible to reduce the 3% investment return on the pension fund to be 2.5%, in line with the FCA guidance on pension projections (get ready for a real onslaught of newbies on this board from April 2014 when the lower rates become compulsory for use in annual statements).

Finally, the state pension is more like an index-linked annuity than draw-down. Rather than using 3.3% drawdown, I think you should use a rate of 2.4%, based on the information for a single-life index-linked annuity for a 55-year-old on this site: http://www.pensionchoices.com/annuity-rates/index-linked-annuity-rates/.

I haven't reworked the arithmetic, but we all know it'll be unpleasant.

Worse, retiring at 55 with a state pension age of 70 leaves one open to the risk of an increase in the state pension age after one has left the workforce. Given the implied ten-years-before-pension rule, it would be unsafe to retire before one had reached 60 -- or you need to build in even more contigency, for a worst-case increase of two years in the state pension age before one gets within ten years of it.

Warmest regards,
FA