Six financial mistakes to avoid when retiring10/11/17
Financial decisions made at retirement can sometimes be irreversible and bad ones can haunt you for a long time. So here’s my rundown of six financial mistakes to avoid when retiring:
1. Not reviewing your options
Prior to Pension Freedoms, research* showed around 80% of those who bought an annuity internally (from their original pension fund provider) did not shop around. This is madness! We’re not talking about a 12 month electricity contract, this is an income you will be paid for the rest of your life, in excess of 30 years in some cases. A small difference in the monthly payment can amount to a considerable amount of money over time. Research** from the Financial Conduct Authority shows that 8 out of 10 people would have benefited from switching providers.
Different providers will offer to pay you different amounts, based on their best guess of how long you might live. Some providers specialise in offering you more money if you have health issues, referred to as ‘Impaired Health’ or ‘Enhanced’ Annuities. They don’t have to be major issues either, high blood pressure, smoking, a bit overweight etc could all mean higher income payments. Whether you employ a Financial Adviser or not, shopping around is a must.
2. Underestimating the NHS
Our National Health Service is exceptionally good at keeping us alive. Yet our own understanding of how long we might live hasn’t quite caught up with their speed of progress. If you choose a flexible income on retirement, rather than a guaranteed income for life (annuity) the single biggest risk for consideration is you outliving your pension pot. According to the Office for National Statistics, a 65 year old man today has a 25% chance of living until 94 and a 10% chance of living until 99. For a 65 year old female the result is 96 and 100 respectively.
For a lot of people, retirement is a 30 year plus life stage.
3. Ignoring the power of inflation
As I write this inflation is sitting at 3% (Consumer Price Index). But what does that mean for your retirement? Well it means that you need to consider which of your income sources will increase over time and which will stay level.
The state pension for example is currently subject to what is referred to as a ‘tripple lock’. This means that each year State Pensions in payment will increase in line with the higher of the three measurements: Inflation, Average Earnings or 2.5%. Great, so even if a loaf of bread or a pint of milk costs 3% more next year, your state pension will have risen too. Of course this is subject to current or future government meddling!
But what about your other income? Will that keep pace? Does it need to?
If inflation continued at 3% and your household bills kept inline, in 20 years time something that costs you £100 per month now, would then cost £181 per month. That’s a cumulative rise of over 80% in just 20 years.
4. Running away from risk
One of the biggest money mistakes we see people make is running away from risk completely. Keeping a certain amount of money in cash, where it can be accessed quickly and easily without penalty is rule #1 in good financial planning. However, in most cases this shouldn’t be everything. There is no set amount to keep in cash as it is very much dependent on someone’s circumstances, but as a general rule of thumb somewhere between 3 and 12 months normal expenditure would be expected. This is an ’emergency fund’. If the boiler breaks down, the roof starts leaking, or the car leaves you stranded on the side of the motorway, you’ll need a cash buffer available to get you out of trouble.
Leaving any more than this in cash, with rates as low as they are today, leaves you open to mistake number 3. If you manage to get a 1% return on cash at the moment you are doing quite well, but with inflation at 3%, you are losing 2% of your spending power year after year and slowly eroding your the money that you probably consider ‘safe’.
Now not everyone needs to take risk. Some people have enough money for the rest of their lives even allowing for the depreciating value of their cash, but do you? How much risk would you need to take to give you a good chance of the retirement you desire?
The key thing to remember about risk is that it isn’t binary. It’s not risk vs no risk, there is a huge area in between. Investment risk should be specifically matched to three key areas specific to YOU:
1. How much risk are you willing to take? – you need to be comfortable and not awake all night worrying!
2. How much risk are you able to take? – you might be willing to take risk, but can you afford to?
3. How much risk do you need to take? – in order to achieve your desired outcome.
Getting risk right is very important, but risk itself shouldn’t be considered something to run away from.
5. Not involving your family
Talking to family about money. In general we’re really not very good at it, but why? I’ve seen children get almost nothing that were expecting much more, and parents too afraid to really enjoy themselves despite having plenty. Neither were good family outcomes.
The happiest families seem to be the ones that are open and honest about their finances with each other. If you have a detailed financial plan with plenty of excess, why not give some away now? You can see the benefit of your hard work and watch children or grandchildren enjoying it. Plus if planned correctly, you may even save Inheritance Tax in the process.
On the other side, I have seen children persuading their parents not to hold back, go for those cruises, buy that camper van, don’t worry about their inheritance just enjoy your financial freedom and make the most of life! But if you don’t discuss these things, you’ll never know how everyone else feels.
6. Not having a plan!
The summary of all of this? make sure you have a plan! There is plenty to consider and lots of it not in this blog, but if you start by avoiding these 6 mistakes there’s a good chance you’ll be well on your way to a happy and successful retirement.
If you have any questions about anything in this or any other blog, or you have any particular subjects you would like me to cover in future blogs, I would love to hear from you. Please send me a message at email@example.com
* Pensions Policy Institute Briefing Note No. 102
** Financial Conduct Authority, Thematic Review of Annuities, Feb 2014.