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Review your income in retirement strategy

Taking a ‘haircut’ in lockdown 

Phil Smithyes, Partner, Head of Financial Planning 
breeze blown by dandelion

From a financial perspective ‘lockdown’ has resulted in people taking a closer interest in their financial affairs than they otherwise might.

The initial shock to global markets caused by COVID-19 saw asset values fall sharply, with moderate to high risk investors seeing portfolios fall by up to 20%+ in March and April. However, as the panic subsided and governments and central banks stepped in with a package of fiscal stimuli, equity markets recovered strongly in May, with the US S&P 500 index having its strongest month since 1987.

Equally, with the shops, pubs, bars and restaurants all closed, there was less opportunity to spend and so, although income was inhibited for many, especially the self-employed and those who were furloughed, expenditure also reduced. As a consequence, the financial squeeze on household budgets has, for many, not been as tight as first feared.     

Challenges for those who have retired

For those in retirement the challenges have been different, both from a shielding perspective and in respect of their finances.

Many retirees are reliant on their savings and pensions to deliver their required income in retirement. Historically low interest rates, dividend cuts and falling asset values have placed significant pressure on those seeking to generate a consistent and sustainable income. Withdrawals are often made up of a combination of natural income yield or interest and capital drawdown, as this helps when it comes to generating a consistent and tax efficient income.

All retirees face the same financial challenges when it comes to structuring their finances:

  1. Providing an income for an unknown period of time (lifetime) whilst offering flexible adjustments as their circumstances change.
  2. Protecting their income from sudden and sharp drops in asset values. Guarding against sequencing risk.
  3. Continuing to deliver inflation beating returns so as to protect the value of their income in the future.

Impact of falling asset values on your withdrawal rate

At a simplistic level, a requirement for a £20,000 distribution from a portfolio of £500,000 equates to a withdrawal rate of 4%. Over the medium to long-term, a medium risk investor would hope to achieve this return through a combination of capital growth and investment income and, ideally, maintain the value of their capital in real terms.

However, if asset values fall then the same £20,000 income would represent a 5% withdrawal rate on a reduced portfolio value of £400,000. This places greater pressure on the underlying portfolio and increases the probability of capital erosion.

Lower rates of withdrawal rate come with less risk, but need to be balanced with the changing income requirements during retirement and ever evolving economic conditions.

 Annual Rate of Withdrawal 4%  5% 
 Chance of running out of cash 9%  26% 
 Approximate portfolio value after withdrawals 63%  33% 

Once the withdrawal rate falls to 3% or below, the probability of running out of money over a 35 year retirement falls to just 2%*.

One of the biggest risks for retirees who want to use their pensions for income in retirement is the risk of large negative returns early on. This is often called sequencing risk and it has significant implications for anyone using a drawdown strategy.

Taking a haircut

Most pension plans and investment portfolios offer the flexibility to be able to increase or decrease, or stop and start withdrawals without charge and without penalty. This facility can prove invaluable in times such as these, as it allows retirees to take what is known in the industry as ‘a haircut’ to their income. This avoids the need to sell assets at a low point in the investment cycle and reduces the likelihood of accelerated capital erosion in the short-term.

Review your strategy

Investors should seek to revisit their income and expenditure requirements and, where prudent to do so, reduce their withdrawals for a period until such time as things return to normal.

If you would like to review your income strategy in retirement then please speak with your financial adviser or contact one of our Financial Planning Consultants who will be delighted to discuss your options with you. 

*The above figures are for indicative purposes only and are not guaranteed. Source: Investec Wealth & Investment.

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Phil Smithyes
0118 959 7222
Thames Valley
Miles Clarke
0118 959 7222
Thames Valley
Adrian Crowe 
020 7842 7187
Richard Dean
01242 234421
Aron-Gunningham    Aron Gunningham
0118 959 7222
Thames Valley
Julian Hanrahan
01622 767676
Dharmesh Upadhyaya
020 7842 7325

Risk warning

Crowe Financial Planning UK Limited is authorised and regulated by the Financial Conduct Authority (‘FCA’) to provide independent financial advice.

The information set out above is for information purposes only and does not constitute advice to undertake a particular transaction. Appropriate professional advice should be taken on specific issues before any course of action is pursued. Any advice provided by a Crowe Consultant will follow only after consideration of all aspects of our internal advice guidance.

Past performance is not a guide to future performance, nor a reliable indicator of future results or performance. The value of investments, and the income or capital entitlement which may derive from them, if any, may go down as well as up and is not guaranteed; therefore investors may not get back the amount originally invested.

The Financial Conduct Authority does not regulate estate planning or tax advice.

Contact us

Phil Smithyes
Phil Smithyes
Partner, Head of Financial Planning
Thames Valley