Retirees must expect the unexpected when enjoying their later years
The pension freedoms have increased the allure of early retirement for many savers who have now been given greater control over how to spend their pot. Instead of slaving away in a job until the age of 65 then living off an annuity, why not do something that is adventurous while you have good health?
While adventures are fun, they do require careful financial planning to ensure they end well.
How advisers can help clients realise their ambitions to enjoy early retirement in a sensible way is tricky. Advisers say the conversation with a client who wants to retire early is very similar to the one with a client who wants to retire at state pension age or later; they need to consider the motivation that drives the desire to retire, create a robust investment strategy and prepare for unexpected life events.
Equally important though are honest conversations about how much a client will need and be able to spend sustainably in order to support the style of retirement they want.
Nonetheless, early retirees do face greater risks of running out of money and their portfolio suffering from potential market downturns compared to later retirees.
This is a long list of issues to tackle, so where should advisers start a meeting with a client who wants to retire early?
Laying the groundwork
Advisers Money Marketing spoke to argue that technical questions about tax efficiency, withdrawal rates and asset allocation are not the immediate priority.
BKD Wealth Management director Brendan Dixon says: “The two questions you need to answer from a client perspective are: how do you want to spend your retirement and how much will it cost?
“Once we arrive at that figure we revisit it with the client on an annual basis. We are agnostic about what that number is, but once we have it we revisit it in meetings with the client.”
EQ Investors director Jeannie Boyle says: “The conversation you have with a client who wants to retire early is fundamentally the same one you have with someone who wants to retire at 65.
“As an adviser the questions I need to answer are what sort of retirement does the client want, do they have the assets to support their aspirations and, if not, what assets do they need?
“Sometimes in these conversations it becomes apparent there has to be a dose of realism as clients need to compromise to achieve goals.
“For instance, would a client want to live frugally now in order to retire earlier? With every conversation it is usual to find there is a different attitude to risk.”
Boyle says advisers have to consider the unexpected tragedies life can throw at clients with equal sensitivity regardless of when they want to retire.
She adds: “I have seen people who lived very frugal lives but tragically they have died before they could enjoy their money. Therefore, if you have clients who are a couple, the adviser has to ensure each partner has enough money to survive. Everyone has to be well-protected as tragic things can happen.”
Director, Cervello Financial Planning
At our firm the question we always start with is what does enough money for the client look like, irrespective of when they retire? You have to begin here because any retirement age is made irrelevant if people eventually run out of money.
Once we have that answer we then work backwards and build the cashflow model and tax-efficient solutions from there.
The process for building portfolios is the same: work out the client’s attitude to risk, capacity for loss and then try to bridge the gap with the investment strategy.
The longevity lottery
The fact advisers have to make whatever investments clients own work longer for them due to early retirement is a major challenge to overcome. Any attempt to match an appropriate investment strategy to a client’s estimated longevity is hard. The same is true for calculating how much money they can sustainably spend in retirement.
Last April, the Institute for Fiscal Studies published research arguing that advisers need to have a better grasp of how long clients will live in order to make successful retirement plans.
The study revealed large and systematic biases in individuals’ expectations that are important for them if they want to take better control over their pension wealth.
It said those in their 50s and 60s underestimate their chances of surviving to age 75 and spend too much money.
Conversely, individuals in their late 70s and 80s overestimate their chances of surviving to age 90 or above and spend too little money.
To mitigate this longevity roulette Boyle says: “You have to be very robust in your cashflow planning so a client does not run out of money. During a normal length retirement, which lasts for, say, 30 years, a client can expect one or two significant market downturns.
“If they retire early an adviser has to build in even more robust planning for a higher probability of downturns.”
One strategy Boyle champions is part-time work that can both cushion the shock of a market downturn and reverse a client’s desire to stop work completely.
She says: “When I see clients looking to retire I am always curious to see whether the motivation is positive or negative. One of the things we see with clients in high-earning and high-pressure jobs is a desire to leave early because of stress.
“So if the motivation is negative then maybe an adviser can help them find something in their life that is positive, which would maybe inspire a different view of retiring early.”
Work part-time to sustain early retirement
The fundamental point to bear in mind is if you retire early the money must last longer. Research shows for every year a person delays retirement they improve the sustainability of income by eight to 12 per cent per year.
The way to think about it is if you retire at 64 and take £10,000 from your portfolio, this could be improved if you wait for another year and take the money at 65. That delay generates investment growth and you could take £10,800 from the portfolio instead of £10,000. A person who retires early should be prepared to take less money from their portfolio, and they may need to be invested more in equities to generate income growth.
Another important point is what do we mean by early retirement? Clients may start retirement early but could work part-time for a better work/life balance. I argue it is useful to consider earnings as an asset class, so if an adviser can reframe the conversation from stopping work to working part-time, opportunities can be created.
If a client is in a high pressure and high income job, they will probably be able to continue earning in a consultant capacity. They could work part-time and still earn a decent amount and be happy. Then the drawdown is a way to augment their work earnings rather than fully draw down on the portfolio.
Abraham Okusanya is director of Finalytiq
An adviser can only start work on a suitable investment strategy after a client’s motivation and financial objectives are clear. Here is where advisers’ views on what the best asset allocation is for early retirees do vary.
BKD Wealth Management’s Dixon points out that an adviser may have to recommend an investment strategy that is more aggressive than a client’s risk score would otherwise suggest to help them retire earlier.
He says: “An issue with some younger conservative clients who score low on appetite to risk is it suggests they should be in bonds when in fact they should be ‘shooting the lights out’, so to speak [if they want to retire early]. They should be in less risky investments about 10 years before they want to retire.”
Navigator Financial Planning director David Crozier says that his company takes what he believes to be a “controversial” stance for early retirees as it insists clients have a cash buffer for immediate spending so they do not have to touch their pension.
While he says many argue such money should be invested in the markets to generate growth, he believes this misses clients’ emotional needs.
Crozier says: “Currently our firm has a client who is already early retired and has two-and-a-half years of disposable cash even though he has been taking money from his pension.
“We have told him ‘you do not need to do that, so stop taking money from your pension and just live on your cash’. The purist view is other than a bit of emergency cash, you should invest the rest of the client’s money in the markets.
“With our approach you can say: ‘You don’t need to worry about markets because you have a cash buffer’.
“Right now, I would not like to be looking after a client who is depending solely on their investment growth to live.”
While advisers can and do recommend contrasting investment strategies for early retirees, they must understand their motivations to develop a suitable strategy.
Threesixty director Russell Facer says: “The key thing is to understand the motivation of the client who wants to retire early.
“If the adviser does not work this out then it is likely the advice they give will not be suitable.”