The upside-down world of retirement

Nita has to build wealth over the next 35 years so that she has assets to draw down on in retirement. To do this she must generate an income from which she must meet her living expenses - to house, feed and educate her children; and have some enjoyment of life. When these items are fulfilled she will hopefully have surpluses to put aside for her retirement.

There are some factors that will help her, namely employer pension contributions if she works for someone else, and income tax relief on her own pension contributions. The biggest calamity that could affect her and her family would be if she is no longer able to work or she dies. The probability of her having to cease work through disability before age 65 is less than one in 10. There is around a one in eight chance that she will die before age 65.

Joe will generate no income from his own activities in retirement. Apart from his state pension, which is unlikely to be sufficient to meet his essential spending on food and housing, he will have to draw down on his accumulated wealth to finance his retirement. There is a one in four chance that he will spend at least six months in a nursing home and a one in six chance he will incur care costs of over £100,000. What’s more there is less than a one in 10 chance that Joe will be alive in 35 years.

We can already begin to see why attitudes need to reverse once someone has reached retirement.

Nita’s objective is to generate sufficient income that will enable surpluses to be put aside for her retirement. She must however not lose sight of the risks premature incapacity and death may cause. The problem is the incidence of these risks is so low which makes it difficult to persuade people of the need to take out insurance.

Joe’s objective is to run down his wealth over his lifetime so that after taking account of his state pension he can fund the retirement lifestyle that he desires. The problem he faces is that he could be blown off course by incurring substantial care fees, or that he lives longer than he expects. The problem is that any pre-funded care plan is likely to cost more than he is willing to pay from the wealth he has accumulated. The risk is that death occurs later than expected and Joe either runs out of money or he has to severely curtail his spending part of the way through his retirement.

When it comes to investment, the same upside down worlds occur. Nita will not be overly worried over most of her saving period by the effects of market fluctuations. She will realise there are advantages in buying when markets are low, in fact when markets are high she may hold back on investing her savings until after a market correction has occurred.

Joe on the other hand has the opposite problem. He needs to sell assets in order to realise part of his retirement income. Selling assets in a depressed market will reduce the time over which his portfolio will sustain the income he requires. He still needs income however and therefore he should consider selling over-valued assets to build a cash fund that can be called upon when markets plunge.

The way the residential home is viewed also creates an upside down world. Nita will want to pay off her mortgage so that she can enter retirement debt-free. The equity she builds up in her home will help her feel secure. Joe may well look upon his house as part of his wealth that will pay his retirement income. He may release part of the equity he holds by way of downsizing, adding to the investment wealth he will draw upon to provide him with retirement income. He may instead take on mortgage debt through a lifetime mortgage to provide the same.

A mortgage taken on by Nita has to be serviced by at least paying interest. This reduces the surpluses she can put aside to save for her retirement. A lifetime mortgage releases equity that can be used to augment Joe’s income.

The whole world of financial planning gets turned on its head the moment individuals reach retirement and advisers clearly need to factor this into the advice they provide. In a very true sense, retirement is an upside-down world.