How much can you spend after you retire?

Investors need to change the way they approach taking an income from their pension to get more from their money in retirement.

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.

Subscribe to MoneyWeek

Become a smarter, better informed investor with MoneyWeek.

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.)

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.

Advertisement - Article continues below
"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).



Personal finance

Companies cut back on their pensions bills

Britvic is the latest firm hoping a cheaper inflation index will cut pension costs. David Prosser reports.
28 Aug 2019

Good news for pensions savers from HMRC

HMRC has withdrawn its appeal over breaches of the pensions lifetime allowance.
28 Jun 2019
Personal finance

Don’t miss the pensions deadline

There are just five weeks left in the 2018-2019 tax year, so make sure you’ve made full use of your allowances.
6 Mar 2019
State pensions

How much extra state pension you will get if you delay claiming it

If you delay claiming your state pension by a year or two you could end up much better off in retirement.
13 Feb 2020

Most Popular

UK Economy

Britain has a new chancellor – get ready for a major spending splurge

The departure of Sajid Javid as chancellor and the appointment of Rishi Sunak marks a change in the style of our politics. John Stepek explains what's…
14 Feb 2020

Money Minute Friday 14 February: The latest from RBS, Britain's state-owned bank

Today's Money Minute previews results from RBS – Britain’s state-owned bank – and from pharma giant AstraZeneca.
14 Feb 2020

Living on a houseboat: the pros and cons of a floating home

Living on a houseboat sounds romantic and peaceful. But it’s not as straightforward as it looks, says Nicole Garcia Merida
14 Feb 2020

Is 2020 the year for European small-cap stocks?

SPONSORED CONTENT - Ollie Beckett, manager of the TR European Growth Trust, on why he believes European small-cap stocks are performing well.
12 Feb 2019