Your Retirement Salary summary

The substantial pension arrangements enjoyed by the postwar generation came to an end in the 1980s. Two factors explain this development: increasing average life expectancy and falling returns on investments. 

In the past, people didn’t live nearly as long as most people in the developed world do today. On average, anyone born in Britain or the United States before 1940 was lucky to make it past 70. Today, however, we assume that our parents and grandparents will live into their eighties or nineties. 

However large or small your pension pot, you will need to withdraw enough money from it to cover your living costs without running out of cash before you die. Let’s kick things off by focusing on how to manage one part of your pot – returns on investments. 

Some investments produce income automatically. Quarterly dividends generated by a stock market fund, for example, are simply deposited in your personal pension account. The same applies to investment trusts. 

Imagine a retiree called David with a $300,000 pension pot. He owns his house and needs just $15,000 a year to cover his expenses. To hit his target, his investments must generate an annual natural yield of five percent. The market, however, only gives him 4.24 percent. That’s $12,709, leaving him $2,291 short.

Like many savers, David’s assets don’t generate the income he requires, and he’ll need to sell some of his capital. Isn’t that a slippery slope leading to financial ruin? Not necessarily. The trick is knowing what proportion of your pension you can sell off without running into trouble later on. 

As you take an income and sell a portion of your capital, your pension pot will shrink. As we saw in the last blink, this process can be managed by selling no more than one percent of your income-generating assets every year. If you knew how long you would live, this method would work perfectly until the end. Longevity, however, is an unknown factor in your calculations. 

The older you get, the more likely it is that this system will break down. That’s a scary prospect: every extra year you haven’t planned for is a year without income. This means you need a back-up plan.

If you own a house, it’s likely your biggest asset. Does that mean you should be using it to fund your retirement? In most cases, the answer is “no.” Let’s see why. 

Taking money out of your home is called equity release. As the name suggests, you are freeing up or “releasing” a property’s value or “equity” without selling it outright. Generally, this is something older folks do, and the majority of equity-release mortgages are only available to borrowers aged over 55 or 60. 

It’s an unpleasant subject, but there’s no getting around it – we all need to plan for what will happen to our assets and income after we die. This is vital, because understanding this issue may change how you plan your retirement, especially if you want to deliver better tax outcomes for your heirs. 

Annuities and final salary pensions can be inherited and will continue to be paid out to your nominated heirs after your death. Typically, your spouse will receive half or two-thirds of your income, though this depends on the terms you concluded with your provider or employer. In most cases, this arrangement has no immediate tax implications.