PHILIPPA: Welcome to The Pension Confident Podcast with me; Philippa Lamb. Now, back in episode 11, we talked about preparing for a happy retirement. This month, we’re going to talk about spending rather than saving. What’s the best way to manage your money once you retire? And how do you make sure you don’t run out?
Picture the scene: you’ve been saving into your pension for years. Finally, the day has dawned and you’re there, you’re retiring. But there’s a cloud or two on your horizon. You don’t know the smartest way to start withdrawing your retirement cash and you don’t know how long you need to make it last. So to run through everything you need to think about when you start withdrawing a pension, I’m joined by three expert guests. Mark Jones is Product Director at Legal & General Retail. Hi Mark.
PHILIPPA: Next, we have a returning guest and a good friend of the podcast, Financial Journalist and Founder of Much More With Less; Faith Archer. Nice to see you again Faith.
FAITH: Hello, good to be back.
PHILIPPA: And also back for another appearance, PensionBee’s Head of Product; Martin Parzonka. Hi Martin.
MARTIN: Hi. Good to be back as well.
PHILIPPA: As usual, before we start, please do remember that anything discussed on this podcast should not be regarded as financial advice and when investing your capital is at risk.
So everyone, it’s a big day when you retire. I know we’re not there yet. But after all those years of working and saving, it feels like it’s going to be a day to celebrate. Have you ever thought about what you might do the day it happens?
FAITH: You see, I think I’m not entirely sure when I’m going to retire. Because I’m a freelancer, I think I’m envisaging a much more phased retirement, so I might switch to working part-time rather than full-time.
PHILIPPA: So there won’t be that one day?
FAITH: Maybe there will be. Maybe on the submission of that Iast article. I think for me, going out for a big lunch because I wouldn’t normally do that on a working day. That’s something I’d look forward to.
PHILIPPA: Yeah, that’s a nice idea.
MARTIN: I think that rings true. I don’t really see retirement happening because we’re all gonna have to work a bit longer, right? When I quit, or ‘mini-retired’ from my career back in Australia, the first thing I did was sleep in, that was it.
PHILIPPA: We can all identify with that.
MARK: Perhaps I’m a little closer. So I’ve thought about it a little bit. I’m a natural optimist. So, I have this wonderful idea that my retirement will coincide with Wales playing at the Rugby World Cup, and I’ll go out there and watch them lift it for the first time.
PHILIPPA: That’s obviously going to happen as well.
MARK: Absolutely, guaranteed.
PHILIPPA: I hope it does. It’s gonna be a big disappointment otherwise.
A lot of us are just thinking about retiring sooner, aren’t we? Since the pandemic, the number of people in their 50s and 60s who aren’t working has gone up by over a quarter of a million. And as I understand it, for more than half of them, that’s because they’ve decided to retire. So, we do all need to think a bit about when we might stop working. But it’s this question about predicting how long we’re going to live? If you don’t know that, how do you know how much to spend and when?
MARTIN: You can predict it. There’s a thing called death-clock.org on the internet, you can plug in some details. I’ve got about 42 years left, according to that.
PHILIPPA: Oh, that’s so grim!
FAITH: Yeah, well I must admit, I hadn’t heard of the death clock. I just went to the boring old Office for National Statistics. I’m 52, so it reckons my average life expectancy is 87. But, I’ve got a one in four chance of living to 95, or a one in 10 chance of living to 99. I don’t particularly want to get to 87 and realise, ‘oops, I’ve run out of money’. So I’m basically planning, just assuming that I’m going to live to 100. That’s the basis I’m looking at. It’s a lot of years ahead to be planning for.
MARK: It absolutely is. I’m an Actuary by trade, we create some of these numbers.
PHILIPPA: Death clock’s all about people like you then!
MARK: I mean, some people define Actuaries as those who know when you’re going to die or make sure people are dead on time and all those horrendous ideas. But it only works on maths, as you say. It’s all proportions, it’s all percentages. So no one knows how long they’re going to live for. And more importantly, though you run the risk of running out of money, there’s also a risk of not spending it and enjoying it. So it’s a really big decision, whichever way you look at it.
MARTIN: That’s a really good point. I think using 100, it’s an easy number to remember. So, planning for death at 100 makes sense for a lot of people. Like you said Mark, people may not spend and enjoy their money, but I guess that’s also part of legacy planning, right? You might think about how much you want to leave to people when you do move on. So there’s a lot of things to take into account.
PHILIPPA: Well, there are because if you’re looking at another 10 years, beyond what you might actually live. I mean, that’s a substantial reduction in what you’ll spend every year, isn’t it?
MARTIN: Yeah, it is.
MARK: And it depends how much you want to spend. Most people have big plans when they retire and they assume they’ll be spending less as they get older. Then potentially, they may want to think about long-term care of some variety at the back end. So it’s possible that your spending potentially goes back up.
MARTIN: People don’t think about how much they have to spend on care later in life. I reckon that’s gonna be a miss for a lot of people. Humans have an optimistic bias naturally, right? And they forget about the bad stuff that happens. I’m going to need someone to look after me when I get to that age, potentially. That’s why it’s important to take care of yourself now. But I think there‘s a gap for people thinking about that and financial products to suit longer-term health care.
HOW TO ACCESS YOUR PENSION MONEY
PHILIPPA: Okay, so we definitely need to think about this, as we’ve just established. But Faith, you can’t just take your pension money when you feel like it. So can you just remind us what the rules are?
FAITH: Well, to be fair, in the brave new world of pension freedoms, if you’ve got a defined contribution pension, you can take the money when you reach the age of 55 (rising to 57 from 2028). But, I wouldn’t necessarily recommend you do that. Because I think what a lot of people forget is that your pension isn’t exactly the same as a savings account. You can only take 25% of your pension savings out tax-free. The rest’s taxable. So if you’ve decided, ‘right, I’m going to take that whole lot out in one year’, it could push you up the tax brackets, so you’d pay far more in income tax than you need to. Than if, for example, you’d spread your withdrawals over several years.
PHILIPPA: Now, there are various ways you can start taking that money when you retire. Should we kick off by explaining what they are and how they work? And then I would like to take a look at the pros and cons of those. So Mark, should we start with annuities? Shall we just say what an annuity is? It’s a financial product, you buy it, when you retire?
MARK: You buy it when you retire. People get concerned about annuities. They think they’re very complicated. But in the simplest terms - you have a lump sum you pay and for that lump sum, you’re told you’ll get an amount of money until you die. Whatever happens to you, whatever happens to your health, whatever happens to the economy, whatever happens in the world, it’s an absolute guarantee of a fixed amount of money that carries on.
There are options that you have. So, you can have it increasing. You can have it so it’s guaranteed to last a number of years, even if you die early. You can have it so it goes to a spouse when you die. All these are elements that’ll impact the price. So, you’ll get a little less each month. But more important than anything else is the really simple idea of - you pay this amount of money that you know and you get this amount of money that you know until you die.
PHILIPPA: So Faith, what’s drawdown? How’s it different from an annuity?
FAITH: With an annuity, you hand over a big lump sum in exchange for guaranteed income. With drawdown, you hang on to your money. So it stays invested in the stock market and then you have the freedom to decide how much you withdraw and when. That means you benefit from growth, but potentially there’s that risk that if you spend too much, you could run out of money.
PHILIPPA: Okay. Pros and cons to choosing?
FAITH: I think for me, one of the big pros about an annuity’s peace of mind. You know what’s gonna happen, you’ve handed over your lump sum and you know your income isn’t going to run out. Unless you choose an annuity that only lasts for a certain number of years, it’s going to continue for as long as you live. I guess the good news is that annuity rates are linked to interest rates, we’ve seen interest rates increasing. So now you get more income than you used to.
PHILIPPA: Yes, because for a long time annuities haven’t looked like a very great deal haven’t they? Because interest rates had been so low. But they are really healthy now.
FAITH: They’re looking more healthy, but still, if you go for the drawdown option - where you leave your money invested and choose how much you take out and when, you’re the one that benefits from any investment growth, if you’re being optimistic. You hope the stock market will continue rising, that your fund will grow, and if you don’t gouge enormous sums out of it, that the money will last you.
So it gives you a lot more flexibility and a lot more control. With an annuity, because you know what you’re getting, there’s no flexibility if you have a phased retirement. So if you take out an annuity while you’re still working, you might end up paying more tax. With drawdown, you’d have the flexibility to say, ‘you know what, I’m just going to take small sums when I’m working part-time, and then I’ll ramp up and take a bit more later on’.
MARK: And the other option, of course, is you don’t have to do one or the other. One of the things that’s becoming perhaps more thought about these days, is that you can use an annuity to guarantee a level that makes you comfortable, gives you the peace of mind referred to and then maintain some in a drawdown state, such that you can then benefit from investment growth. And perhaps be a little bit more adventurous in your investment choices, because you do have that guaranteed underpin.
PHILIPPA: Okay, so you’re not spending your whole pension pot on an annuity, you’re chopping a chunk of it out for that and then being a bit more flexible with the rest?
MARK: Yes, depending on how much you have in your pension pot. If you’ve got a pension pot of over a million pounds, then you’ve got an awful lot more freedom and less concern about not being able to cover the basics in life.
MARTIN: There’s these new products being kicked around, I think. I only found out about this yesterday. Our Director of Public Affairs reached out to me and said, ‘hey, what do you think about these?’ It’s called decumulation pathways, and I thought she was talking about investment pathways, which is a Financial Conduct Authority (FCA) initiative. Is this potentially confusing to the consumer? Probably, I was confused. I thought we were talking about this other thing.
PHILIPPA: And you know about this stuff, so that’s not great, is it?
MARTIN: So, decumulation pathways are where you do get the annuity and flexi-drawdown blend. And so, it’s proposed to the consumer and there’s some modelling that’s done that they set aside a flexible amount. So how much do you want to have the flexibility of leaving invested. Like you said, it can grow or decrease depending on the markets. And then you do have this guaranteed element. Now, the guaranteed element is pooled with other people that buy the product. So, it’s kind of like an insurance product where other people’s funds are put together. So people that die earlier than expected forfeit their funds and those that live longer than expected, do better. Well, they have the guaranteed element paid out to them. So it measures the longevity risk, or accounts for longevity risk by pulling funds. So it’s interesting, complicated, but interesting.
MARK: I think that’s what it comes down to. It’s the level of simplicity against complication. Possibly the easiest way to think of the most of the old fashioned with profit funds, because that’s effectively what this is. And with profit funds worked very, very well for a long period of time.
PHILIPPA: Just remind us how they worked.
MARK: Again, it’s what’s called pooling of risk. So the idea is everyone pays in the same amount and depending on what happens, you get paid different amounts out. So that if someone dies early, they won’t get as good a value as someone who lives longer. So you’re basically…
PHILIPPA: Gambling on how long you’re gonna live!
MARK: Yeah, well, I suppose we all are, all the time in that respect. But I think that’s the big element. The simplicity against complexity. For some people, they’ll make absolute sense, they’ll get very comfortable with that. For others, they want absolute simplicity. The one bit I would really be keen to get out is that annuities nearly always have the option of being underwritten. So they’ll take account of your lifestyle and your state of health. It’s really, really important that you answer those questions. Because depending on your lifestyle, for example if you smoked, or if you have smoked, you can get a better value annuity.
PHILIPPA: And that’s, just to be clear, because they think you’re going to die sooner.
MARK: Absolutely. That’s the reason. It’s a pure economic piece. Obviously, if you take out an annuity when you’re older, you’ll get better value. Because you’re older, you’ve got to live a shorter lifespan. But also there’s a higher probability of you having something that you can put on this underwritten annuity and therefore get better value as well. The con side of that, of course, is at what age do you want to be making these financial decisions?
PHILIPPA: Yes, when you don’t know what sort of situation you’re going to be in and what state of health you’re going to be in if you leave it that late.
MARK: Absolutely. It’s about how much confidence you have.
MARTIN: I think what’s key there’s just starting early. No matter what product you choose, at the end of the day, whether it’s an annuity or flexible drawdown, start thinking about it as soon as you can. Start putting money into the pension, getting that beautiful tax relief from the government to top up your pension pot. And then you’ve got options. You can make the choice when you need to make the choice and you’re a bit more flexible with it.
PHILIPPA: Is it fair to say people have been frightened of annuities in the past? Because it’s this business of how do you choose which one to go for? You have to shop around for one, don’t you? And I think people don’t feel equipped to do that. How would you do that?
MARK: Part of the regulations now mean that if you go to a provider to purchase an annuity, they’ll take you through the quote or you’ll do it online and you have the opportunity to try all the different options, and see the impact. If another provider would then give you better value for that, the provider you’ve gone to will tell you that. So it’s a far more transparent piece. So you’ve got confidence about whether you’re getting the best price for the choice that you’re making.
FAITH: I mean, let’s face it, people are becoming much more accustomed to shopping around for different financial decisions. If you think about comparing car insurance, home insurance, mobile tariffs and so on.
Annuities are another financial product where you can look for help online from a financial advisor or from the person that provides you a pension if they offer annuity options. So I think people are getting a greater level of comfort and it’s absolutely worth shopping around and comparing what you can get. I think people may have had concerns about annuities because it’s a big decision. You’re handing over a big chunk of money that you’ve saved up over decades in return for an income that’s potentially going to take you through the rest of your life.
PHILIPPA: And you cannot change your mind. Once it’s done, it’s done.
FAITH: Once it’s done, it’s done. But I think the comfort for me - you were talking about potentially making the decision in later life. And I think I can imagine if I was 55, 65 - I’d be quite happy having a chunk of money in drawdown, keeping an eye on the stock market and thinking about how much I should or shouldn’t take out. But later in life, when I’m 75 or 85, I’m not sure I want to be worrying about that. So I could imagine delaying an annuity purchase until I’m older and iller. I’m gonna get more income and I don’t want the hassle of looking at investments and managing them. And so, having that combination over time.
MARK: We did some research and we found just shy of a million people; 990,000, when over the age of 55 and still at work, were now considering annuities for the first time. That’s on top of the 828,000 in that category who already were. So it’s more than doubled. I think it’s largely because of the interest rate rises which mean you get better value. But I think there’s been more discussion in the media about it. I think people are getting a little bit more comfortable with the idea that it’s not that one thing’s good and one thing’s bad. There’s a more nuanced and better coverage of this subject in the market.
PHILIPPA: Yes, as Faith says, people are getting used to shopping around, aren’t they?
HOW TO MAKE A PENSION WITHDRAWAL PLAN
PHILIPPA: So, we know what the options are and we know we need a withdrawal plan. Shall we get into how you make one? Because there’s this big mindset change, isn’t there? When you’re switching from saving to spending. And it’s quite difficult to know how to make your money last.
FAITH: I think it’s a huge mindset change. I know I’ve spent quite a lot of my life making sure I put decent amounts of money into my pension. I’m now counting down the years until I can retire. I’m quite hopeful I might be able to quit before I reach the State Pension age. Part of me is like, ‘Yes, I can get hold of that money and go travelling. The kids will’ve left home. I’m out of here!’
PHILIPPA: She sounds quite pleased about that, doesn’t she?
FAITH: Oh yes, I’ve got lots of plans. But on the other hand, there’s that kind of doubt, if I blow it all by going around the world and having that new kitchen. There’s not really gonna be much left with my 100 year forecast. I think if you have spent so much time saving, then the actual reality of spending it can be a big decision. I think I have a concern that people will have so much fear about running out of money, that they won’t take enough money to enjoy their retirement properly.
PHILIPPA: Yeah, it’s an understandable anxiety, isn’t it? A horrifying thought to think you might not have enough when you’re really old.
FAITH: But horrifying if you end up on your deathbed thinking, ‘Oh my God, I’ve got all that money left. It’s just going to my children! But I could’ve been living it up’.
PHILIPPA: This stuff’s not easy is it? So, shall we think about spending sensibly? How you reach those sorts of decisions. Because obviously, as you say, you don’t want to blow the cash, but then you don’t want to end up sitting on a huge cash pile when you finally die. So Faith, the costs you need to cover when you retire. Most things that stay the same, don’t they?
FAITH: There’ll be some things that stay the same. You can certainly do some kind of budget, looking at what your costs are now. Your basic bills: council tax, water and electricity, that kind of thing. You can also have a serious think about what costs might change. If by the time you retire, you’ve finished paying off your mortgage. If you, for example, wouldn’t have the same commuting costs or the cost of smart clothes for work. Thinking of it over time, the ‘U-shaped’ spending pattern. I’ve seen it described as the ‘go-go years’, ‘slow-go’ and ‘no-go’. With go-go, you’re doing all the travelling and the eating out, and all the stuff you love. Then with slow-go, perhaps your health isn’t so good, you can’t do so much. And then no-go, when suddenly your money’s going on care costs.
PHILIPPA: The other thing that occurs to me’s that we’ve seen some very turbulent economic years recently. We’re talking about pre planning here, but global events like the invasion of Ukraine and the cost of living crisis - these are things you can imagine happening, but they are hard to plan for. But you do need to factor in some element of unexpected downside when you think about all of this.
MARK: Practically impossible to plan for, isn’t it? That’s, I think, where the personality comes in as much as anything else. The people who’re willing to accept this will happen. There’ll be good times, there’ll be bad times. Some of the bad times might be very bad. Some of the good times might be very good. As opposed to those people who really don’t want to worry about any of this. That don’t want any risk at all. And those people who say, ‘well, I’m willing to take some risk, but I want that underpin’.
MARTIN: Yeah and just assume inflation’s going to happen, right? We’re seeing a massively high rate of inflation at the moment. But over the long term, it’s been about 2% or 3%. And the central bank’s target is 2%. So, most online calculators will factor that in. When you make your plans, think about what you need to set aside to cover it. There’s also the sustainable rate of drawdown that’s purported of 4%. Do you guys buy into that? So, if you assume you’re going to get 4% on average return on your investment. So, drawdown 4%. year on year, when you’re on the other side of that, when you’re withdrawing. Does that ring true?
FAITH: I’d seen 4% quoted as a figure by the ‘FIRE movement’, Financial Independence, Retire Early, on the basis that if at year one, you took out 4%, you could then take that amount increased by inflation and that would not completely erode your lump sum. I thought it was more if you took out larger sums above the 4%, that you might be in serious trouble.
MARTIN: Yeah, those guys popularised it, the FIRE movement.
FAITH: I mean, I think it’s a rule of thumb. It’s quite a good way to think about it. But I think in practical terms, if you haven’t gone down the annuity route with a guaranteed income, if you’re not lucky enough to have a final salary, defined benefit pension, where you know exactly what you’re getting and if you’re looking at drawdown, there’s the risk of what the hell’s happening with stock markets. And depending on how stock markets do during your retirement, whether they soar or plummet at the beginning of retirement, that can make a big difference to how much money you’re left with.
But one of the really practical things you can do’s make sure you’ve got a decent stash of money in cash, at least a year’s living expenses. Because that does mean if you’re doing drawdown and you’re potentially at the mercy of the markets, if everything goes to hell in a handbasket - you don’t have to sell your investments when prices are low. You can get by using the cash.
And I think also in early retirement, if you’ve identified in your budget, what your essentials are and what’s nice to have, then you might make decisions depending on how your investments are doing to rein things in a bit. That’s what I mean about how you may have to monitor things. So that’s your personality, age and health. How much do you want to be thinking about managing your money?
PHILIPPA: Mark mentioned earlier this question of how much your pension pot has in it as a determinant of how you choose. What do we think about there? Are the rules of thumb that are useful?
FAITH: I think another thing that’s a mindset change at the point that you start retirement’s that you may be going from a single income stream to funding a retirement from multiple different places. The State Pension will kick in at 67, well, 66 currently, but the age’s rising. Lots of people actually have multiple workplace pensions now. So you’ve got different pots in different places. You might be lucky enough that some of them are final salary, others are defined contribution. But also, you might have savings and investments, outside pensions.
PHILIPPA: ISAs, that sort of thing?
PHILIPPA: Yeah, so you really do need a plan. This is the message of the podcast. You do need to think about this stuff. And before the moment arrives that you need to make the decision.
FAITH: Yeah, because the decisions you make could last for the rest of your life. If you buy an annuity, if you hand your money over to scammers, if you take a massive withdrawal from your pension and then carry on working - that’ll restrict how much money you can pay into a pension in the future. It can really cut down on the amount of pension tax relief you can get. So there are big decisions that have lasting effects.
PHILIPPA: Yeah, so this can all sound a bit anxiety inducing. But I think the thing to reiterate is, the more you think about it, the more you plan - the lower your risk of a bad outcome, right?
MARK: There’s an awful lot of tools available to help people with this. I think most financial institutions will have tools on their websites. The government has the Pension Wise opportunity where you have a free service to get some advice.
PHILIPPA: Yeah, we’ve talked about that on the podcast.
MARK: At Legal & General, we have a retirement planning course that we’ve done with the Open University. It’s independent, it’s unbiased and it’ll just help you think about a lot of these things as you go through it.
PHILIPPA: That brings me to kind of pretty much my final question which was: when should you start working on this withdrawal plan we’ve been talking about? But as you say, those tools are there. And there’s no reason why you can’t have a little play with those at any stage. You don’t have to be imminently thinking about retirement, do you? It’s just that idea of thinking ahead. What might you do? How might it work? What resources have you got?
FAITH: Yeah, and the free Pension Wise appointments are government organised service and those appointments are available from the age of 50. It’s completely free. It’s guidance explaining what your options are. So what you could do, not necessarily what you should do.
PHILIPPA: Before we wrap up, I do think it’s worth remembering that getting older isn’t all totally bad news. Because actually, there are quite a few benefits out there. Price reductions that you can take advantage of that young people don’t get. I’m thinking about reduced prices at galleries, cinemas, that sort of thing. Benefits too. This is all cash.
FAITH: I’ve written articles listing reams of them. Things like getting a senior railcard, getting a free bus pass, getting reduced membership at things like the National Trust and English Heritage. If you look out for pensioner specials in cafes, restaurants and pubs. The fact that once you’re retired, you’re no longer tied to travelling during school holidays and at peak times. You can go midweek, you can go in the off-season and take advantage of significantly reduced prices. There are many things to look forward to.
PHILIPPA: You see, it’s like I said. It’s not all bad news.
MARK: Well, it’s beautiful weather at the moment. My 81 year-old father-in-law went off cycling around the Purbecks yesterday. It’s not a financial thing, but it’s a gorgeous benefit.
PHILIPPA: Yeah, you cannot buy time. It sounds good to me. Thank you very much indeed.
Once more before we go, please remember that anything discussed on the podcast should not be regarded as financial advice. And when investing, your capital is at risk.
Next month: at some point in your life, you might think about having or adopting children. Or you might get together with a new partner who already has some. If that happens, you’ll be spending for two or more, and kids aren’t cheap. So how can you plan ahead financially for having a family?
Join us in July for that one. To catch this and all future episodes, subscribe on your podcast app. They’ll arrive the moment they’re released. And why not give us a rating and review while you’re at it? It doesn’t take a moment. Thanks for being with us. See you next time.
As always with investments, your capital is at risk. The value of your investment can go down as well as up, and you may get back less than you invest. This information should not be regarded as financial advice.