Case Study 2: James wants to achieve a retirement income of £26,000 p.a.

Scenario: James is 55 years old, divorced father of two. He is in good health and is looking to retire in line with his state pension age which would be 66. He is aiming for a retirement income of £26,000 per annum. The current source for his retirement income is his pension fund which has a fund value of £114,500. He will also qualify for the full state pension. He has a disposable income of approximately £750 per month after essential and social expenses.

Thoughts:  James has 11 years to retirement. When he retires he will qualify for the new state pension of £7,865 per annum or £151.25 per week. This will leave his pension fund to make up the shortfall of £18,135 per annum. Based on current best buy annuity rates of 5.8%, James will require a fund value of £312,672 in order to purchase a secure retirement income of £18,135 to supplement his state pension.

If James wants a secure income which can only be achieved by way of purchasing an annuity, then he would have to start making some serious pension contributions. This would need to be in the region of £700 per month, provided the fund achieves a consistent growth rate of 7% per annum. James could also make a one-off contribution of £70,500 now in order to improve his chances in closing the fund gap.

But how realistic would it be to achieve 7% growth per year consistently for the next 11 years. Bear in mind this would also have to be net of fees and if the total cost of your investment is 1.5% per year you will need your fund manager to return at least 8.5% to cover their fees too.

This rate of return means James would need to be invested in a higher risk category to maximise his possibility of reaching his target growth fund of £312,672. But realistically, how many of us out there can really afford to save £700 per month? As for James, despite the fact his disposable income is stated to be £750 per month, slightly above the amount he needs to save, this is very tight. I have yet to see accurate and reliable expenditure details. Life is simply not consistent. Furthermore, he probably only disclosed his standard social expenses forgetting that amount we tend to spend on impulse.

It would be great if we could make more impulse decisions to save rather than spend. Investors and savers need to become more literate on a whole host of things that can affect their lifestyle in retirement. James’s situation could have been far better if he saved even a small amount per month consistently from the age of 20, reinvesting all of his dividend income and benefitting from compound growth.

Putting money aside just feels like another ‘expense’ and also another ‘task’ and in that sense providers can assist with technological and software developments. This can facilitate a more collaborative relationship with the investor by bringing their investments to their fingertips by making use of mobile and portable devices. This way savings and investments needn’t feel like they are in a distant place removed from the investor. By working with the investor to recognise and achieve a particular financial objective it could give UK investors a solid opportunity to build their savings and investments portfolio not simply by way of a regular direct debit but also by way of impulse especially at times when markets are low and when investors have that extra little amount to put away.

Anyway, back to the topic at hand, we have established James needs to start investing in a high risk fund but by no means is this performance target guaranteed and it is this that James must consider carefully. If he has a Financial Advisor, among many other things, he or she would be exploring his tolerance, and capacity to take investment risk whilst also exploring potential catastrophic life events.

Tolerance largely relates to James’s psychological and emotional profile which is usually assessed by way of a psychometric and scenario based questionnaire. Capacity is about the portion of your overall wealth that you are effectively investing and/or the effect a loss in your investment value will have on your lifestyle. Be careful here though as you may be ok with a loss in your investment in the second year of your investment but what if it dropped by 50% just before you intended to withdraw from the market?

Then there’s the case of thinking about how to mitigate catastrophic life events that could lead to a loss of income and/or an increase in expenditure due to paying for healthcare or home support.

All of these things will temper James’ exposure to risk which could mean he has to compromise on meeting his retirement goals. Compromising may mean reducing the level of secure income he takes and keeping the remainder of his monies invested in order to allow for growth or simply taking no secure income thus drawing on his investments directly. Bear in mind during retirement, James is unlikely to be invested in a high risk fund in case he were to suffer a very poor year and would need to divest more of his capital in order to meet his income needs, thus overly risking his entire retirement income. This in turn means, his potential rewards would also be significantly lower.

Consider that average life expectancy is approximately 82 years. This would mean James would need a retirement income for 16 years.

James could transfer his current pension into the high risk fund in accordance to his risk profile without any plans to make any further contributions. If this fund grew at the targeted growth rate of 7% per annum, he could have a pension fund of £246,740 in 11 years’ time.

Provided he didn’t take his 25% tax free lump sum, he could withdraw £1511.25 per month or £18,135 per year assuming a growth rate of 4% net of charges which should see him through his retirement.

James has an opportunity to realise his goals however, it will require a strong need for planning from now and ongoing reviews of his entire estate, income and ambitions to ensure his retirement goals are on target. Who knows, he could have forgotten the fact that he may want to fund his daughter’s wedding sometime in the future.

In any case, the lesson is, invest now. Think about what goals you could potentially have when you get married, when you have children, when you could want to take a gap year and then do what you can even if it be by making bitesize contributions now.