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Kirk Rice Blog

Retirement Income – How To Take Income At RetirementWritten on October 24, 2019 by Kirk Rice LLP

Retirement Income – How To Take Income At Retirement
Financial Services Questions

The Question:

I plan to retire early next year when I will be entitled to my state pension of £8,767pa. I have a deferred final salary pension of £5,700pa and a money purchase pension which has a current value of £270,000. I plan to take this using drawdown and will take the 25% tax free lump sum and add this to our savings of £100,000. My wife is already retired and has a state pension and a small annuity. We will need additional income of £1,500pm which will be funded from the drawdown and our savings. What level of retirement income can I expect from a drawdown, will it be able to fully fund the £1,500pm?

Kirk Rice LLP answers:

I assume the target of £1,500pm is the amount you need after tax. If you take the 25% tax free lump sum (£67,500) from your pension, it will boost your savings to £167,500 and reduce your pension to £202,500. Any withdrawals from the £202,500 will be subject to income tax. To receive a net amount of £1,500pm, you need to withdraw a gross amount £1,875pm (assuming basic rate tax at 20%). Once tax is deducted the net amount received by you would be £1,500pm. The gross amount of £1,875pm equates to £22,500pa and you would need an investment return of 11.11%pa to generate this from the £202,500. This is clearly high and realistically withdrawals at this level would inevitably see the value of the pension reduce, and eventually it would be depleted. This is why I use the word withdrawal when describing how to take money out of the pension rather than income; to highlight you would be using capital to fund the income. The 11.11% return needed does not look too promising.

However, if we include your savings the picture improves. The combined value of your pensions and savings is £370,000. The return now required to generate £22,500pa is 6.08%pa. Still high, especially when you consider the interest rate you could expect to receive on a savings account at present, but certainly better than 11.11%pa. This does assume you have not allocated some or indeed, all of your savings to another purpose. I have identified the return you need to generate the required retirement income; but the first part of your question was actually, what level of income can you expect? This very much depends on the level of risk you are prepared to take. As an advisory firm, we work with a risk scale of 1 to 10 with 1 being low and 10 being high. Each risk score has an expected long-term average return. Risk score 3 (low risk) has an expected long-term average return of 3.75%pa. Risk score 5 (medium) has an expected long-term average return of 4.98%pa and for risk score 8 (high risk) it is 6.79%pa. Arguably the long-term average return is the percentage you could expect to withdraw from a drawdown pension and maintain its capital value.

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In practice investments do not provide an average return; it varies year on year; some years will be a lot better than the average whereas other will be a lot worse and negative. The higher the risk the larger the negative return. During years when the return is negative (the pension fund is falling), it would be sensible to stop taking withdrawals and use your cash savings instead. Charges will need to be allowed for and of course inflation as withdrawals need to increase each year to keep pace with increases in the cost of living.

You also mention taking the 25% tax free lump sum from your pension and adding it to your savings. Assuming you have no specific need for it, you could leave it in the pension and each month take a regular withdrawal that consists part tax free cash and part taxable income. As an example; if you took a withdrawal of £1,765pm; 25% / £441 could be paid as tax free cash. The balance of £1,324 would be taxable and based on tax at 20% the net amount would be £1,059 giving a total net income of £1,500.  A withdrawal of £1,765 (£21,180) equates to nearly 8.00% based on a fund value of £270,000. Still high and realistically the value of a pension will reduce. In practice, you may want to take less to make the withdrawals more sustainable and take the balance from your cash savings.

Overall it seems likely that your pension and savings can fund the income you would like but at the expense of capital. It would be sensible to look at cashflow modelling to get a better understanding of when the money would run out. In general terms; long term care aside, most people spend less once they are in their 80’s and it may be that you could incorporate reduced income in the cashflow. Drawdown pensions are very good and offer a great deal of flexibility, unfortunately, this also adds to the complexity so do get advice from an independent financial adviser.

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TAKING INCOME AT RETIREMENT

Any reader interested in finding out more about the withdrawal strategy for retirement income, should email info@kirkrice.co.uk to arrange a call with one of our financial planners.

 

Please note: Answers are given for general guidance only and specific advice should be taken before acting on any of the suggestions made. We base the information on current tax legislation which may change in the future. The FCA does not regulate tax and trust advice.
Information is based on our current understanding of taxation legislation and regulations. Any levels and bases of, and reliefs from taxation, are subject to change. Taking withdrawals may erode the capital value of the fund, especially if investment returns are poor and a high level of income is being taken. This could result in a lower income when the annuity is eventually purchased.

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