TT Wealth, Office13, Edwards Business Park, Pontyclun CF72 8QZ
How to get your retirement priced up
Is it possible to apply a price to your retirement?
And if it is, what use does this have?
The answer to the first question is “no” – it is not possible to say with certainty how much any individual’s retirement will cost. There are too many variables which cannot be known in advance.
However, as an exercise, it is possible to apply assumptions and see what the retirement cost, or price, is based on those assumptions.
If you think about a Mortgage for example, something similar applies.
When you take out a mortgage to buy a house you cannot know for sure what the eventual total cost of that mortgage will be.
The mortgage will come with a quote which shows you the total cost, based on assumptions linked to the interest rate and the duration of the mortgage, how quickly you repay it and so on.
With retirement we can help you get a quote for your retirement, the “price” of your retirement, based on doing two things.
This is useful because it can help you quantify something which is otherwise difficult to quantify and at the same time it can be revealing to show you how close or otherwise you may be to affording this “price”.
It’s not a concrete exercise, which you can rely on stand alone, but it is useful, very useful, to act as a steer and, possibly, a starting point for the planning that will need to follow.
Here’s what you need to do to get your retirement “priced up”:
Get an index linked lifetime annuity quote
Run a long-term cash flow and income/expenditure model
Put these two things together and it will indicate a highly accurate picture and an attached figure.
John and Jean are close to retirement and want to know their ‘figure’.
They need a certain set level of income from their current ages, for the rest of their lives. The income needs to go up a little each year to cope with cost of living rises.
That income is £35,000 per year.
They can seek out a unisex quote for an index-linked lifetime single life annuity.
This shows they need £840,000, based on their current ages.
It may be that an adjustment can be made, for example if they are receiving or expecting to receive state pensions. If their state pensions were going to be (or are) £10,000 per year, then the income can be adjusted to £25,000 (£35,000 – £10,000).
The index-linked lifetime single life annuity is reduced accordingly to £600,000.
£600,000 “buys” an annual income for life – adjusted for inflation – of £25,000, their state pension produces £10,000 also increasing each year, giving them their desired target of £35,000 per year.
That is a starting point, the £600,000 figure is notionally the price of their retirement, after taking into account their state pension.
If John and Jean, in this scenario, only have assets (capable of producing an income) totalling £300,000, then they cannot meet the price of their retirement.
There’s a lot more they need to look at and discover, but top level they can see a shortfall, which means something has to give.
(For example, they may need to wait a few years to retire, adjust their income expectations down or look at some other form of generating income or cash to give them enough, such as downsizing their house or considering an Equity Release).
In some ways the index linked annuity quote is a fairly crude pricing mechanism, but it is mighty accurate in at least quantifying – top-level- the sort of wealth/income figure.
That’s why everyone should get such a quote, as it provides a guide or a ‘ballpark’.
The trick, though, is not to treat this as a pinpoint figure. Now the ballpark has been established, the next step helps identify the price further.
That is to run a lifetime cash flow analysis.
(See here for more about how cash flow works – https://overlandfit.com/why-a-cash-flow-forecast-is-crucial/)
Using their ages today, their current assets (£300,000) with an income coming from this (say, of 4% per year increasing a little each year), their state pensions locking in, any other income sources, or windfalls, their expected retirement dates, and their anticipated expenditure all plugged into the software, this will produce a long-term income/expenditure forecast and personal balance sheet. This will show when, if ever, they will run out of money.
It is likely that the software will show them running out of money.
That’s because they have a state pension of £10,000 per year and £12,000 per year coming from the assets (4% of £300,000). That’s £22,000 per year. £13,000 short of their £35,000 target.
They will need to dip into their assets to top up their income. And over time this will (probably) deplete the income producing assets, so they will produce less income, meaning more cashing in of the assets, to top up the shortfall.
That will eventually lead to £0 left in the assets and if this happens when they are, say, ages 84 and 86 respectively then they are seeing a future where later in life they are left with just their state pension(s).
With the cash flow software, you can see when you run out of money. If this never happens, based on the assumptions and expectations, then you have your retirement ‘price’ covered.
If John and Jean run their cash flow and see they run out of money at ages 84 and 86 respectively, they can re-run the forecast changing their actual £300,000 to another figure, using all the same assumptions.
If they change it to £600,000 and this shows they will run out of money but beyond their respective 100th birthdays, then that £600,000 price established by the index-linked annuity quote in step one, starts to feel reliable.
Overlaying step one and step two and getting an index-linked annuity quote, backed by a comprehensive lifetime income/expenditure forecast, is an exercise every retiree trying to work out the price of the retirement should be doing.
The point of looking at retirement in this way and trying to calculate the price of an individual retirement (i.e. your retirement?) is to hone the mind into a reality borne out by the current retirement market and the projected future position.
Most people are probably unable to adequately quantify what their retirement price is, and this runs the risk of massively under-estimating the prospect of running into financial difficulties or challenges later down the line.
Alternatively it means many people may have to reduce their lifestyle wishes, leave a smaller legacy, have care provided by family or the state, or spend their last years with perpetual money worries.
Remember the suggested mechanisms outlined above are an exercise, aimed at helping with making smart decisions, about an unknown future.
In particular, doing it this way, helps to think about how to build longevity insurance into a retirement plan.