As with a lot of things in finance, decumulation can be a bit complicated! At its most basic level, decumulation is the process of turning your pension savings into income to fund your retirement.
Most people will have an idea of what they would like their retirement to look like. Whether you’re wanting to globe trot before age slows you down too much, take up sky diving, or spend more time pottering in your garden, you need to make sure you’ll have the money to realise those ambitions, and continue to support yourself as you grow older. Considering how you’re going to take your pension is a very important decision.
The process of decumulation can be a bit daunting. You’ve spent all of your working life building up your pension pot. When it comes to spending it, it can be hard to make head or tail of your options, let alone decide which would work best for you. Especially as you want to make sure that you don’t outlive your savings!
New pension freedoms were introduced in 2016
In 2016, new pension freedoms were introduced. It made the options of what you do with your pension pot once you retire a lot more flexible. Before this point, the main options were purchasing an annuity or selecting to drawdown.
An annuity acts as an income. It ensures that you will get a set amount of money for the rest of your life, or a set number of years, whichever you choose when you buy your annuity.
Since the new pension freedoms were introduced, flexible drawdown has become the most common option for taking your pension. This option allows an individual to dip into their pension pot as and when they like. One potential issue when doing this, however is that you run the risk of running out of money.
More and more, we are seeing individuals using their pensions almost as a savings account, accessing it as and when they need money for big ticket items such as holidays and new cars.
What does the reality look like?
To give you some context, the average pension pot for a 55-65 year old is £105,496. The amount required to live comfortably in retirement is £1,360 per month.
Running these figures through our cashflow modelling tool demonstrates that unless you’re planning on dying young, you will have a shortfall…
For our “average” male, aged 65 in good health, if you started taking your pension immediately, your funds will be depleted by age 77.
If our “average” male opted to take the 25% tax-free lump sum he’s entitled to when he starts taking benefit (known as the pension commencement lump sum, PCLS) – a tempting £26,374 – the fund would be depleted by the age of 73.
Either way, you could still have a lot of years ahead of you!
If our “average” male bought an annuity with his pension pot, he would only achieve an income of £466.53 per month, with this figure dropping to £349.48 per month if he took the PCLS first. So that doesn’t seem to be the answer either.*
So the scary reality at the moment? Anyone who has only managed to accumulate the “average” pension pot by retirement faces some very difficult decisions on how to best use those funds.
The key message here: start saving as early as you can, and save as much as you can!
How to choose your decumulation pathway
Before you do anything with your pension pot, it is so important that you speak to a financial adviser. If you end up living a long life you want to make sure that there’s money left right until the end. A financial adviser will be able to answer any of your questions, so you can be confident that your pension pot will last as long as you need it to.
What we do at Face to Face Finance
At Face to Face Finance, we prepare a comprehensive report as you approach retirement. It assesses your current situation, your objectives, your attitude to risk and your capacity for loss.
In addition, we run through all of your options for decumulation at retirement. This will enable you to feel confident that you can make the right decision about how to fund your retirement lifestyle.
If you are approaching the time in your life where you need to start thinking about decumulation, get in touch. We would be happy to go through your options with you and help find the right solution for you.
*These figures take into account a state pension of £164 per week from age 66 which will pay until death, return on pension pot of £4.62%, inflation at 2.5%.