How would you answer a client who asks how much income their savings will provide them in retirement? Could you say what pension pot is needed for, say, £20,000 annual income?
The answer to that last one, for a 55-year-old looking to retire in 10 years, is just over £550,000. Or, to put it differently, £27.75 in savings today for each £1 of income in the future. I will explain how we can put such a precise figure on it in a moment.
For anyone without a defined benefit pension, retirement (in most cases) used to be as simple as shopping around for an annuity. Now, pension savers are faced with all sorts of risks. Longevity risk: will my savings run out before I do? Sequence risk: have I considered how my investments will perform if I withdraw money at a bad time? Investment risk: what happens to my retirement if the stock market crashes?
Savers also have a dizzying array of product options. Rather than selecting from a list of annuities, they can now pick anything from blended products to high-yield bonds to overseas property. All this before we even get to the new issue of tax efficiency and legacy.
Put simply, individuals are now largely responsible for their own retirement, with all of the choice, risk, and responsibility that involves. And not many know what to do to get the income they want.
Given all of that complexity surrounding new retirement choices, simple tools can be an excellent way to kick off retirement discussions. The figures above – £550,000 for £20,000 income – come from an interactive online tool developed by BlackRock to help visualise retirement choices.
It is possible to combine interest rates, inflation and mortality projections, among other factors, to generate an instant estimate of the income a client’s savings may provide in retirement. This helps answer the question “what can I expect when I retire?” and, as it is a lifetime measure, the impossible-to-answer question “how long will I live?” is taken off the table entirely.
There are obviously plenty of ways to calculate potential retirement income. One way is based on annuity pricing methods. This gives an indication of the income someone could expect if they ‘cashed out’ of their investments and annuitised. Annuity providers are hugely experienced in pricing future income, and using their methodology essentially brings institutional level forecasting to the everyday investor.
How to use it
1. To get a retirement bearing
A 55-year-old who has saved diligently has a pension pot of £250,000. He currently earns £30,000 a year and he has no idea what portion of that income could be realistically replaced by his savings. It is possible for an adviser to give this client a precise, ‘live’ estimate of what type of income he is on track for.
For example, if his current retirement income level is £27.75, dividing £250,000 by this amount gives an estimated income of £9,009.
