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The risks of running out of money in retirement

If you’ve taken advantage of the new pension freedoms – or you’re planning to in the future – you need to be sure that what savings you have will last as long as you would like them to.

While possibly not inclined to blow it all on the now-infamous Lamborghini suggested by Pensions Minister Steve Webb – and you can read about the tax implications of doing just that in 'The REAL cost of that Lamborghini' – you need to be aware of the risks that your money might not last as long as you would like.

Important questions to ask

The investment industry is obsessed with fund returns and looking at funds’ performance, in spite of the constant disclaimer that ‘past performance is no guide to future returns’.

However, Professor Robert Merton, an economist at investment management company Dimensional, argues many people are concentrating on the wrong thing when looking at their investments – he believes concentrating on whether the pot has grown by a set percentage or met its targets has little bearing on whether or not said pot will actually be able to meet your income requirements in retirement.

Professor Merton says there are three major questions worth bearing in mind, which should shape how you go about providing for your retirement:

  • How much income do you want in retirement?
  • How much do you want to contribute?
  • When do you want to retire?

And as a possible fourth question, which cannot be underestimated, even if no one can answer it: how long are you going to live?

As an example of how people are living longer, figures from Age UK, for the first time in history, there are 11 million people aged 65 or over in the UK, while those aged 50 or over now make up over a third of the total UK population. Looking forwards, almost a third of the UK population will be aged 60 or over by 2058.

With all that in mind, how can you try to ensure that your retirement funds don’t run out?

Planning for the long term

While most ‘rules of thumb’ estimate that people need around two-thirds of their previous salary to live on in retirement, Danny Cox, chartered financial planner at financial advice firm Hargreaves Lansdown, suggests many people’s living costs remain the same.

“You need to consider the essential living costs – the absolutely must-haves - and then the preferred level of income – the nice to haves - and work out your financial plan accordingly,” he says.

It is important to have a secure basic level of income with some form of guarantee to count on. “This might be your state pension, an annuity or company pension schemes,” Danny says. This can then be ‘topped up’ with variable income streams, such as money from savings in ISAs, drawdown from other pension funds, or rental income from property, for example.

It is important to have the resources to be able to supplement your income because if you decide to opt for drawdown and take money out of you pension pot like a savings account, the harder rest of your investments have to work in order to stop the pot falling to an inadequate level.

Adrian Lowcock, head of investing at Axa Wealth, an investment company, agrees it is important to have a mix of assets to use to fund your retirement and to realise your spending habits will likely change throughout retirement. He describes many typical retirees’ expenditure patterns throughout the phases of retirement as being a ‘retirement smile’.

“At first you spend a lot – paying out debt, perhaps simply enjoying the novelty of not working, travelling and spending time with the family. Next it drops off a bit as you get older and are generally less active, before picking up again as healthcare costs go up, and you need to make sure you plan for that expenditure.”

It is important to have a financial plan in place that covers the stages of retirement – which could be 30 years or more. It is a good idea to seek professional financial advice to assess your requirements and how you may be able to provide for them.

What planning have you put in place to help make sure you have enough cash to fund your retirement? Let us know below or head to the forum to have your say

This article has been commissioned by retiresavvy and any opinions voiced are the author's own.

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