Retirement Planning - Inflation & Growth Rates?

Mothman

I am drawing up a retirement plan on a spreadsheet and finding that trying to work out how much money we will have and need in the future is a toughie. I am unsure as to what figures to use for average inflation & growth rates over say a 20 year period and so if anyone has done something similar I would be pleased to hear what figures they have used. I appreciate that without a crystal ball it’s impossible to predict but I would welcome comments as to whether the following are a realistic staring point.

Average Inflation Rate 2.50%
Average Interest on Cash Savings: 1.75%
Average Growth on Investments (Pensions & S&S Isa) 2.00%

Thanks

hugheskevi

Long term CPI is expected to be 2%, long-term RPI is expected to be 3% (Office for Budgetary responsibility).

I'd assume interest on cash savings would be similar to inflation (2-3%).

Growth would depend on risk profile, using nominal figures (ie including inflation) a range between 5-8% would be reasonable.

One thing you have not asked is long-term earnings, which is important. If you do all your planning in real price terms, you are likely to end up needing more. Imagine you earn around the average salary of £27,000 and you want a similar level of consumption post retirement (adjusting for things which change, eg, no National Insurance, no mortgage, no pension contribution) as you have now. In 20 years time average earnings will have increased much more than prices, but it is likely you would want a lifestyle that is in line with that which the average earner in 20 years has. You may therefore want to increase your consumption needs in the years before retirement in line with long-term earnings growth (4.75%) rather than prices. However, post retirement you may want a lower figure, say RPI. You could be even more sophisticated and model your retirement needs as being U-shaped (high consumption in early years whilst still active, lower when less active, and higher as care needs increase in the years before death).

Loughton_Monkey

I developed my own spreadsheet in 2001, and refined it continuously up until 2006 when I retired early. I assumed 3% inflation, cash savings rate at inflation + 1% [i.e. 4%], House Price inflation 5%, and Investment returns 5%.

I 'froze' the projection (to age 90) the day I retired and compare my actual progress with those frozen figures, despite actuality being somewhat different.

I can report that overall I am "delightfully ahead" and significantly better off than planned. A case of swings and roundabouts obviously but because my assumptions were reasonably cautious, I was never going to be too disappointed.

Even despite stock market 'crashes' I seem to have maintained an actual 7% actual average return. In the early days, I got more than 4% on savings, but of course I now get much less. But if you 'control' actual income and expenditure carefully, you find some virtuous circles. For example, inflation has been less than 3%, and cash interest hardly musters 1½% these days (on new deposits)! But because (a) I exceeded expectations in other quarters, and (b) made savings on spending, I find that I have far more cash than planned, and hence interest in £amount exceeds what the original figures implied at 4%!

We have decent 'cash income' from pensions and supplement it from cash savings. As a result, the proportion of my 'cash' earning 7% in investments helps to subsidise low cash savings rates.

Even so, I still have some stuffed away at well over 2% (but they will mature soon) and with 3% on £20K in a Santander current account, and £40K [between us] at 2.8% and 4% in 'granny bonds', not to mention First Direct's 6% regular saver, I actually get an average not far from 3%.

When your spreadsheet works to an acceptable level, it's not too difficult to do a sensitivity analysis. Play around with your assumptions. Bung up inflation by 1% and see what that does to your spending potential.... Increase investment rate to 5% and see what that does.... It can inform you very well what is important (or more important) to you as individuals.

I feel 100% comfortable with my own situation because (a) my assumptions were reasonably conservative, and (b) I avidly control my financial situation regularly and take actions accordingly. Monitor income/expenditure progress on a daily/weekly/monthly basis but do major planning on a 3-year rolling basis.....

... in other words, don't say to yourself "wow. My model says my investments should have produced £10K, but they brought in £20K, so now I can 'blow' £10K on a new car! No. Account for the £10K in a 'fund' because next year, you may only get £2K, or even lose £5K.

My 'frozen' model informs me that my actual wealth (in £notes) should be less today than it was the day I retired almost 10 years ago. Actually, it's significantly more, and only marginally less in 'real terms'. This has given me the option of either spending more, or having a nice 'buffer' for any future 'disaster' such as a mega-crash, or need for expensive medical care....

michaels

I tend to model it all in 'real' terms as otherwise there is the danger of 'money illusion' making £50k pa or whatever in retirement sound like a lot.

I can see some merit in looking at increasing desired income above what would be desired today based on being worse off compared to average earnings but probably not by the full expected increase in real earnings as I suspect we all tend to be a bit backward looking in terms of being content with what we can afford - ie just because as off now we would like to be at 40th percentile of incomes perhaps come retirement time we would be happy being at 35th percentile.

For example if retiring today I would want 20k and I assume real wages will increase by 2% pa I might use 1% pa uplift on the 20k.

Then I would assume (all pa) 0% real terms increase in cash, 0.5% real income on gilts and 2-3% real increase in shares, not forgetting that normally pension funds are 'lifestyled' with most invested in higher growth 'shares' in the early years but gradually switching to lower growth bonds closer to retirement.

TheTracker

I also model in real terms. Each year I adjust real terms base parameters by real inflation just occurred. For growth I estimate x% above inflation. So no need to estimate inflation.

Mothman

Thanks for the replies. I must admit the increase in average earnings over CPI hadn't occured to me, it's a good point which I need to take consideration of, at least in the early years. I think I will proably also up my inflation figure & cash interest figure a tad as suggested. Looking at my main DC pension, growth has been 5.9% over the last 10 years and so I guess 5.0% would proably be a good conservative investment figure to use rather than my original 3.0%. Will now go and crunch some numbers and see how it all stacks up.

Loughton_Monkey

michaels wrote: »

I tend to model it all in 'real' terms as otherwise there is the danger of 'money illusion' making £50k pa or whatever in retirement sound like a lot........

TheTracker wrote: »

I also model in real terms. Each year I adjust real terms base parameters by real inflation just occurred. For growth I estimate x% above inflation. So no need to estimate inflation.

I agree that modeling in "real terms" is totally legitimate and will work well.

Whilst I have done such models myself, I still prefer the system I use [I modeled in £note terms] because I have used the figures for actual tracking over almost 10 years.

But if we had a sustained period, say, like the 70's with 'silly' inflation of 20%+ I would have to think again.

At the end of the day, [or to be pedantic, the end of each year] my $64,000 questions are (a) Did I maintain my lifestyle totally 100% to my satisfaction [and within budget] last year?, and (b) Do my remaining assets support continuing to maintain the same real lifestyle going forward?

If the answers are "yes", then I'm a happy bunny. The year 2008, I admit, gave me a heart palpitation or two, but things recovered and I find myself with something like three years' worth of spending in 'surplus' [over and above original assumptions]. A very nice 'problem' to have. But I am starting to 'splash out' now and again - like a 5-star extra carricular holiday in St Lucia early next year.

Mothman

Apologies, but I should have outlined our situation in my OP. I'm currently age 54 and my wife is 10yrs older and already retired. We are pretty frugal and currently spend around £25K pa and the intention was for me to try and work part time from age 60 if I can earn £10k pa. and then bridge the gap with wifes state pension and drawdown for cash savings until my DC pensions mature at 65.

If my spreadsheet is a good guide then the money will run out when I'm around 80 (wife 90) but with 100% equity still in the property. There are unlikely to be any fancy holidays or luxurys, but you can only play the hand you've got and so I guess that it will have to do.

hugheskevi

If my spreadsheet is a good guide then the money will run out when I'm around 80 (wife 90)

Just in case you don't know, your life expectancy is around 88-91, depending on assumptions used and assuming you don't have any illness, etc.

Mothman

hugheskevi wrote: »

Just in case you don't know, your life expectancy is around 88-91, depending on assumptions used and assuming you don't have any illness, etc.

I'm sure that's true, however if I work to my new state retiring age my wife would then be 77, which would likely limit the time we have together when we are both in reasonable health. Also I've been in the same job for 31yrs and not sure I could stick another 13:rotfl:

Loughton_Monkey

Mothman wrote: »

......If my spreadsheet is a good guide then the money will run out when I'm around 80 (wife 90) but with 100% equity still in the property. There are unlikely to be any fancy holidays or luxurys, but you can only play the hand you've got and so I guess that it will have to do.

You still have options for the house. Some form of equity release (planned for age 80) might be appropriate. Years ago, many of these were a bit of a 'con' but these days they are more legitimate. The main 'issue' with them is that you are actually spending your estate before you die. Your heirs will be 'poorer'.

Downsizing is a far more efficient way of 'equity release' from a financial point of view, but comes with an obvious [dis]comfort factor.

With no kids, I have both methods up my sleeve. We will almost certainly downsize at some stage [because a lot of our equity is based on 'location' - e.g. good schools - which we don't need]. We want a smaller house anyway as we get older.

The option of equity release on the cheaper house remains just a contingency should either of us live longer than assumed!