How much can you spend after you retire?

published 26 June 2017

Retirement planning used to have two distinct stages. You'd invest in assets that were expected to grow over the long term. When you neared retirement age, you'd sell those investments and either buy an annuity to lock in a guaranteed income or switch into other assets such as bonds or high-dividend shares that would pay you a fairly steady income from your portfolio.

Today, it's not so simple. Annuity sales have fallen sharply since the flexible-access options for pensions came in two years ago. People are choosing to keep most of their pension funds invested and simply drawing down a portion of their income as needed, in order to take advantage of the opportunity for long-term tax-free growth within the pension.

At the same time, record-low interest rates mean that any investments that provide a reasonably reliable income trade at high valuations by historical standards. This is especially true of bonds, but also applies to dividend-paying shares. (The same trend has also sharply reduced the amount of income one can purchase through an annuity today, since annuity rates are essentially based on government bond yields a factor that has probably accelerated the decline in annuity sales.)

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Changing strategies

One implication of this is that investors need to change the way they approach taking an income from their pension to get more from their money in retirement. Instead of dedicating their whole fund to generating a steady income whether through an annuity or an income portfolio they may do better by turning over just part of it to generating a certain minimum level of income. The rest can be left in investments that have higher potential returns, but are expected to deliver them more through capital gains than income. You would then sell down and draw on a portion of this capital each year to provide the rest of your income.

"Investors may need to change the way they take an income in retirement"

Of course, it's not quite as easy as that. Most people are far more comfortable spending a regular income stream than they are drawing on capital, partly because it's harder to know what level of capital it's safe to spend each year without having too great a risk of running out of money before you expect. So frankly, the less confident you are managing and monitoring your investments and doing the necessary calculations to make sure your spending is sustainable, the stronger the argument there is for securing as much income through an annuity or income portfolio. However, for those who want to take a different approach, there are a number of useful tools available online.

Start with the simple bit. Get a forecast of your state pension. The state pension will not be enough for a decent retirement income for most people, but it provides a certain element of guaranteed minimum income (assuming it still exists in this form when you come to retire the further ahead your retirement is, the more you should factor in some uncertainty around this). Also get an estimate of how long you are likely to live. The Office for National Statistics has a tool for this. Finally, if you are planning to use part of your pension to buy an annuity, you can get a quote at the Money Advice Service.

Check how long your pension will last

Once you know these basics, you need to estimate how long your pension fund is likely to last in retirement for a given level of income. Hargreaves Lansdown has a calculator that is relatively simple, but still lets you adjust inputs such as life expectancy and forecast returns to see how changing them affects the result. Fidelity has an even simpler one. Both may be useful for a rough idea of what you can expect.

Finally, if you're keen to take a more in-depth approach, cFIREsim at is an interesting tool, albeit one that requires a bit of work to understand how to use it. It estimates how safe your proposed level of spending is, based on how frequently it would have exhausted your retirement funds too early. You can change a range of inputs, from income sources to the type of drawdown strategy you use. The calculations are based on historical returns from the US market, but this can be adjusted (increase estimated costs to simulate a lower-return environment, for example).

Cris Sholto Heaton is an investment analyst and writer who has been contributing to MoneyWeek since 2006 and was managing editor of the magazine between 2016 and 2018. He is especially interested in international investing, believing many investors still focus too much on their home markets and that it pays to take advantage of all the opportunities the world offers. He often writes about Asian equities, international income and global asset allocation.

Cris began his career in financial services consultancy at PwC and Lane Clark & Peacock, before an abrupt change of direction into oil, gas and energy at Petroleum Economist and Platts and subsequently into investment research and writing. In addition to his articles for MoneyWeek, he also works with a number of asset managers, consultancies and financial information providers.

He holds the Chartered Financial Analyst designation and the Investment Management Certificate, as well as degrees in finance and mathematics. He has also studied acting, film-making and photography, and strongly suspects that an awareness of what makes a compelling story is just as important for understanding markets as any amount of qualifications.