The current environment has provided several challenges for those relying solely on income from investments and savings to fund their lifestyle.
This stage of life is often referred to as the decumulation phase and typically occurs during retirement.
Creating an income out of capital has become more challenging due to a combination of factors, including the present poor value of annuities and the demise of defined benefit schemes. Pensions freedoms legislation has also created a problem for some by reducing their final pot at retirement, an unintentional consequence of allowing savers greater flexibility in accessing defined contribution pensions.
What are the known unknowns?
- Inflation - Since 1900, average inflation has been 3.9% per annum, but this masks large differences. The highest one-year rate was +24.9%, whilst the lowest was -26%.2. In recent years the average has been a little above the Bank of England’s target of 2%, although it has exceeded 8% this year. Coupled with a period of low economic growth there are growing concerns we are entering a period of stagflation, which would be characterised by the combination of persistent high inflation and stagnant demand in the economy.
- Longevity – This comprises two related planning challenges, that life expectancy in retirement has been increasing post war, but in reality, no-one lives an average life, and this can vary significantly depending on where they live in the UK. In some areas, a male retiring at 65 has a life expectancy of 20 years, to 85, but with a 1 in 4 chance of reaching 93.
- Investment performance – Portfolio returns are highly variable, according to asset class and geography. Whilst the FTSE – All World has averaged in excess of 6% including dividends over the last 2 decades, how comfortable is a full exposure to equities in retirement?
- Sequencing risk - This is the danger that a retiree suffers poor returns early on in their retirement, compared to later on, compounded by withdrawing more capital to fund their lifestyle commensurate with onset of retirement.
Where does a financial planner fit in?
A successful decumulation strategy should be unique to each client and must be able to adapt to both their absolute requirements and aspirations, particularly so given the increasingly severe economic impacts of Covid-19 and the invasion of Ukraine.
A financial planner can help achieve this in several ways. Firstly, the decumulation strategy should not be viewed in isolation but as one part of a holistic package of assets which should include all wealth along with other private pensions and the state pension. Taking an overall view of your finances can also have significant tax implications.
Active capital gains tax management can deliver significant savings, such as selling investments showing a loss to offset gains, now or in the future, for tax purposes. While this strategy can be beneficial it comes with some risk and timing can be crucial, as it may go against the prevailing logic of investing for the long-term.
For individual requirements a key consideration centres around any desires for an inter-generational transfer of wealth. Personal circumstances can also vary considerably for example is there still a mortgage to be repaid? Any school/tuition fees? It is important to note that this is not a static phenomenon either, circumstances can substantially change and therefore regular reviews with your Financial Planner can be beneficial.
The value of pensions and investments and the income they produce can fall as well as rise.
You may get back less than you invested. Past performance is no guarantee of future returns.
Tax treatment varies according to individual circumstances and is subject to change.
The Financial Conduct Authority do not regulate tax advice or tax planning.
David Denton
Technical Consultant & Chartered Financial PlannerDavid’s primary role is to collate, simplify, regularly update and share technical knowledge, in a user friendly and practical way, within the Quilter group and with the adviser community. This is to assist with maximising financial planning post-tax investment returns given the complexity and fast changing legislation impacting wealth management.