Don’t worry, it’s OK to spend savings in retirement, but it does come with a caveat.
If you have been diligent during your working life you will have built up a retirement pot through a combination of pension, savings, ISAs and other investment types (shares, buy to let properties etc).
Depending on your work situation you may also be the recipient of a final salary (defined benefit) pension scheme that will provide a guaranteed source of retirement income. If you are really lucky this will provide most of the funds you need to meet your lifestyle costs.
Where a final salary doesn’t provide sufficient income or you don’t have such benefits you will need to meet your lifestyle costs from other sources. Traditionally, an annuity purchased from accrued pension funds was the first port of call but since the pension freedom rules were introduced their popularity has fallen fast (though there are still good reasons to purchase one if a guaranteed income is important to you).
Pension funds still remain the go-to place for retirement income but it does make sense to look elsewhere first. Pension funds, unlike ISAs, property and savings etc, are free from inheritance tax on death and can be passed from generation to generation. If avoiding IHT and passing funds onto children and grandchildren is important deferring taking capital and income from pensions until other, less tax efficient sources first is a sensible approach.
Having worked hard to save money it can feel counter-intuitive to accept it’s OK to spend savings in retirement but, if not in retirement, then when?
It is important to strike a balance; keeping money in savings is important because it will act as an emergency fund that is protected from the vagaries of the stock markets should cash be needed to pay for unexpected costs (repairs to the home, new cars, medical bills, children in need etc).
However, keeping too much in cash means you lose long-term value from the silent wealth destroyer that is inflation. It may also mean you are holding back on living your ideal lifestyle now for fear of needing cash in the future. As long as you are sensible and don’t drain savings too quickly a prudent balance can be struck.
Another common assumption is that any income taken from investment portfolios should be the income (yield) generated with the capital value remaining untouched. But, as it’s OK to spend savings in retirement, it is also OK to spend investment capital and not rely on investment income only.
There are a number of problems with relying on investment income only, rather than withdrawing capital: firstly investment income (dividends from shares, interest from fixed interest securities and rental income from property funds) is highly variable and paid periodically.
The yield from any investment type will depend upon the prevailing investment conditions over time; dividends can be cut in recessions and, as is currently the case with Government Bonds, yields fall when demand increases.
Income distributions from investment funds also tend to be on a quarterly or half-yearly basis making day to day budgeting harder where there is no regular income.
The second, perhaps more significant, disadvantage of investing for income is that it typically requires more investment risk to be taken. With Government Bond yields at an all-time low (currently 1.21% for a 10-year gilt) income investors are forced to take equity risk or invest in sub-investment grade (‘junk’) corporate bonds in an attempt to generate more income.
More investment risk creates more default risk (loss of capital) or intolerable falls in capital values during stock market corrections. Investors who don’t have the stomach for large falls in the value of their investors are more likely to make the mistake of selling at market low points, ensuring capital losses in the process. A double whammy effect of lower income from lower capital values thereby depleting funds sooner (see also this external article for more on the downside of relying on income yield in retirement).
To live your ideal lifestyle in retirement requires planning. Planning well enough in advance so that you have sufficient wealth distributed between the different tax wrappers and planning in retirement so that you neither run out of money before you run out of life nor have too much money left at the end of your life. This requires a strategy that draws capital and income from your different pots and minimises the tax you pay during and at the end of your life.
If you are beginning to think about your retirement and would like a plan for your money let’s talk about it.