Pension Planning Assumptions

DoctorStrange

I'm trying to do my own pension sums as I don't like the online calculators.

If you were putting your own data into a calculator, what would your assumptions be? 

I'm thinking that I should assume 

Death at or by:  85

Income requirement increase each year (i.e. inflation): 3% 

Nominal Growth Rate: 6% (so 3% after inflation)

LTA limit: Stays at £1m

Do these seem fair assumptions? Anything else to consider?


If these do prove correct,  I think I'm going to run into LTA issues so starting to think I might be better using an ISA for future savings rather than a pension. (I appreciate the assumption that there will be no increase to the LTA is conservative but politically I think pensions are an easier target post-Covid, and this is an easy sell).

I'd appreciate any thoughts on how everyone else calculates their pension plans 

Thanks

Secret2ndAccount

First assumption isn't right. 85 is only an average lifespan these days, so you are as likely to last longer as shorter. A healthy 50 year old has a 10% chance of living to 100.

6% average growth after fees is not a given, but I don't think inflation will be as high as 3% either, so maybe it washes out. Recent years have been good to us, but 6% in the long term would be a very solid performance.

Your needs, adjusted after inflation, are unlikely to remain constant. Some people think they decrease because you go from world travel to a rocking chair by the fire. Some people want to pay for the finest care home in their final days, so their number goes up with age. Have a think about your personal views and objectives.

Also think about when your pensions kick in. When can you take work pension? When does State Pension kick in? When do you want to retire?

DoctorStrange

Thanks

What would you put for your Nominal Growth and Inflation figures?

I've already got the State Pension in my calculations, but will consider a factor to reduce the income needed at a certain age. 

I'm looking to retire early using my savings until I can get to my pension, but obviously want to make my forecasts as accurate as possible (without a crystal ball, of course!)

Secret2ndAccount

Bank of England's stated intent is 2% inflation. It's been below for a while so, if it went above for a time I doubt they would jump on it like a gorilla. I would use 2.5% to be on the safe side.

The growth projection is much more complicated. Are you diversified across countries? What is your stocks:bonds ratio? What are your expenses? Could be almost anything, depending on your risk appetite.

Personally I work on a 3% rule. I believe that you can take an annual amount equal to 3% of your initial pot. Each year that number can grow in line with inflation, and it will last a lifetime. This is fairly conservative, so it should work for a wide range of stock/fixed income mixtures.

If things go well, might be able to increase withdrawals above inflation after a few years. Or alternatively can start higher than 3% as long as you are willing to reduce withdrawals should things turn ugly. If SP is a significant portion of your income, can start higher as you know your needs will reduce at SP age.

Linton

You cannot make your forecasts accurate until after the event.  No amount of thinking, studying or listening to investment gurus will change that.  The real purpose of a plan is to give you the confidence to stop working, not to develop an accurate prediction of future income and expenditure which you will follow for the rest of your life.    The best you can do is to make reasonable looking assumptions and then continue monitoring the results updating your plan with reality say once a year. In this way you get plenty of fore-warning should you be going off-course. 

I planned my early retirement nearly 16 years ago on the basis of 3% inflation and 4% return, ie 1% above inflation.  I continue to use the same figures for my ongoing plans.  In the event I have been lucky with inflation lower and returns higher which has left me feeling very confident about the future.  If you want a stress free retirement it would be prudent to ensure your assumptions err towards historic pessimism.

I do not assume ongoing expenditure will generally decrease over time.  Instead the plan includes a series of major one-off items such as long haul holidays every 3 years and a new car every 8 or so years.  These expenses are assumed to stop in my 80's.  Thinking in this way provides slack in both directions.  Should reality turn out worse than planned the major one-offs could be delayed or cancelled without cutting into basic expenditure.  On the other hand if the plans do prove to be pessimistic then one has the opportunity for extra one-offs.   Ensuring that you have to cut basic expenditure in your extreme old age  seems foolish to me as you could find it necessary to pay for care in your home or building modifications.

Thrugelmir

How many years ahead are you attempting to forecast? 

gm0

For simple single "averaged scenario" planning making sure no depletion prior to 95 would likely be better based on current longevity trends as a planning basis.  

No way in hell you can predict out turn to 30-40 years with any accuracy.  Yet it is no comfort that it would have worked for the "average" retiree (across all start dates - what matters to you - is your sequence and single path which may be far from the average).  The spread of terminal fund values is broad indeed. 

So I still think that it's as well to have the ten years from 85-95 considered in the plan even if your discetionary spending may have dropped off your care costs may have increased - unless of course you are taking that one last holiday where you pop off in a champagne fueled hang gliding accident.

Linton

Thrugelmir said:

How many years ahead are you attempting to forecast? 

If that question was for me.....

I believe it is a mistake to regard plans as a forecast.  Forecasting the future with any useful degree of accuracy is impossible and attempting to do so could be counter productive.

My plans which originally were for 40 years and now, worryingly, are just for 20 years are based on what seem reasonably pessimistic assumptions on investment performance, expenditure and taxation.  They calculate the consequences given my current financial situation.  Actions taken now are based on those consequences.  

Every year I update the plan with the current state of my finances.  The original assumptions on inflation and return remain the same as they have worked well but improving finances have made it possible to increase the assumed expenditure.  That is the whole purpose of plans, to determine a sensible course of action now based on mathematics and the best data available.

To give an example where the approach I am advocating differs from a forecast - in the event of a crash someone usng a forecast would reasonably assume there will be a recovery and will only take short term action to avoid depleting equity assets further.  Not wanting to forecast, I will assume that the original assumptions of return and inflation continue to hold from the new situation and if necessary decrease assumed expenditure over the rest of my life.  Relatively small small changes to expenditure assumptions can have a major long term effect.

Albermarle

I think I'm going to run into LTA issues so starting to think I might be better using an ISA for future savings rather than a pension

In simple terms 

If you only get basic rate tax relief then better to start saving more in an ISA, as paying LTA will give you a negative tax return

If you get higher rate tax relief then its a zero sum game

If you get higher rate tax relief and employer contributions you are still ahead 

If you get basic rate relief and employer contributions it will depend how generous they are.

Pension has the advantage of no £20K contribution limit per year and pensions are not included in IHT calculations.

dunstonh

All projections are synthetic and not forecasts.  A forecast is something that is likely to happen.   Whatever assumptions you choose to use in your calculations, you can bet that you will be wrong.

When you decide on your assumptions, you need to decide how risky you want them to be.   Optimistic or pessimistic.  Pension providers assume pessimistic projections.  Too pessimistic in my opinion.  However, its better to be under than over.   Your projections see to vary from reasonable to optimistic.   None of them are pessimistic.      you may wish to tone the growth projection back a bit and extend your life expectancy as you are currently predicting your death occurring earlier than average. (half will get past 85).

And remember that what is considered a reasonable assumption today is unlikely to be considered reasonable in future.    If you look at projections over the last 40 years you will see that what is considered reasonable keeps changing.    

SouthCoastBoy

I have projected out to age 90, using 3.5% growth for equities and 0% growth for cash, with inflation at 2.5%. After the age of 90 I have come to the conclusion that I will not be spending too much anyway. Based on the current spreadsheet when 90 I would have just over £450k in 2020 terms. We'll see how it goes, not retired yet but looking to retire in the next couple of years. Once retired I have based the forecast on the following asset allocation, 60% equities and 40% cash.