The Problem with Pensions: No One Knows How Long They’ll Live
If you are investing online into a SIPP, and many ISAs are also earmarked for retirement, the biggest decisions are generally considered to around making the right investment choices. However, perhaps even more important are two other questions. How much value do you need to build up to get you through retirement and how long will that retirement turn out to be?
Making the right investment choices shouldn’t be underestimated but at least there are some relatively simple approaches that have been tried and tested as historically delivering results over the long term. Passive, cheap large-cap index trackers such as ETFs that mirror the UK’s FTSE 100 or S&P 500 are a good bet and diversifying between a few such index trackers an even better bet, if you have 20 years or so to let any market drops even out. If you are able to put enough away every year to justify the expense, or as a one off payment to help you structure a low risk, long term portfolio, an Independent Financial Advisor can also be a good approach. With a sensible, well-researched or professionally advised approach to building a pension, over 20 years or more an average return per annum of around 5% can be reasonably confidently relied upon.
Unfortunately, when it comes to forecasting how long your retirement will actually be, it’s a lot less predictable. The value of pension that needs to be built up, and how much can be spent every year, to maintain a good quality of life during retirement, will vary immensely between a retirement period of 10 years and one that lasts 30 years.
There is some statistical basis that can give an indication how long a newly-retired 65-year old can expect to live. However, recent research conducted by the Institute for Fiscal Studies shows that we tend to either over or underestimate our life expectancies. The average 65-year old estimates their chances of still being around a decade later at 65%. The reality is that the chances are actually 83% for men and 89% for women. That inaccuracy inverts as we get older. 80-year old males give themselves a 32% chance of reaching 95, while the reality is that only 17% will make it that far. This leads to a reluctance to spend pension wealth that can lead to a lower quality of life in later years than is necessary.
So how much of a pension fund can you sensibly spend? While it depends to an extent on financial markets not hitting an extended rough patch lasting several years, spending 3% to 4% of a pension pot still generating average annual returns of 4% to 5% should mean it lasts as long as might be necessary. This would, however, mean the pension would be the same value at the time of death as when retirement started. While many want to be able to pass down an inheritance, it also doesn’t make sense to try to preserve the whole value of a pension pot throughout retirement at the expense of enjoying life.
Insurer Prudential’s research indicates that, if it returns 5% a year, £9000 withdrawn every year from a £150,000 pension will mean it last from retirement at 65 until the age of 101. However, if it were to return only 1% a year, the same £150,000 pot would be exhausted by the time the holder reached 84. While not an exact science, withdrawing 5% to 7% a year from the starting value of a pension pot should mean it lasts as long as necessary, though it will become gradually depleted over the course of retirement.
Please remember that financial investments may rise or fall and past performance does not guarantee future performance in respect of income or capital growth; you may not get back the amount you invested.
There is no obligation to purchase anything but, if you decide to do so, you are strongly advised to consult a professional adviser before making any investment decisions.