At 47 with a well paid job, I am beginning to think about retirement. I will remain in employment for the next four years but after that want to move to part-time work and some vocational work that I want to do. I will do this to age 55 when I might stop the part-time work. Realistically, how much capital do you think I might need to achieve these goals?
That sounds like a bit of a “how long is a piece of string” type question. However, it is a good question because it prompts a whole series of other questions such as what level of income will you need in four years time and then again in eight years time, when you attain age 55?
Fifty-five is, conveniently, the new age at which you can start to access benefits from any registered pension scheme that you may have. What level of income will you need at each of these key stages in your life? How do you think inflation in the future is going to affect the purchasing power of your income? What capital projects do you have in mind for now or in the future that may reduce the amount of money available to generate income?
I could go on but I guess you get the point that the answer to your question rather depends upon the answers you give and the assumptions we make about the future.
The answer to your question rather depends upon the answers you give and the assumptions that we make about the future
Imagine, for example, that you have an outstanding mortgage. If that mortgage is paid off between now and 55 by the regular repayments that you make, then that won’t reduce the capital you have available to generate income. However, if you, like many people, have an interest-only mortgage, some of your capital is going to have to be used to repay it. But the upside is that if you don’t have the monthly costs associated with the mortgage, you might then need less income in retirement.
It typically makes real sense to pay off debt as soon as you can and that includes not just the mortgage but credit card or overdraft debt as well. Debt is indeed a drag, it does stop us doing the things we really want to do.
Future inflation is also a drag. It reduces the purchasing power of the income that you generate from capital. You may need to plan to have a rising income that deals with at least some of the inflationary pressure. It seems to me that inflation is one of those things that tend to be more noticeable over longer time periods.
How long, by the way, do you intend to live? My seemingly flippant question is quite crucial to the answer you are seeking. You may want to consider some lifetime cashflow forecasting to get the answer to the question, when am I likely to run out of money?
If you have savings and investment capital today, then you are going to need to make some important assumptions about the future. How much is your capital going to grow by over the years?
The higher the rate of growth assumed the less intimidating will be the cost of getting there. But be realistic if you are risk averse and most of your savings and current capital is in cash it would be fairly pointless to assume those monies are going to grow at 7 per cent per year compound. The assumptions that you use for growth should reflect your appetite and tolerance for investment risk and volatility.
You will also have to make an assumption about how you convert your capital into income. What is realistic today may not be in four or eight years’ time. You will also have to take your tax position into account.
Some investment products are quite benign and allow tax-free or low tax income and, of course, tax treatment of investments can be changed by future governments but realistic assumptions can be made.
You may have to factor in some possible disapp-ointments such as having to work for a longer period of time than you anticipate but you are taking the right first step by posing the question.
Nick Bamford is chief executive of Informed Choice