The next instalment of our A-Z Guide to Financial Planning focuses on the letter D - Delaying retirement.
In times of market volatility, pension funds can rise and fall in value. If you are close to retirement, these changes can be difficult to deal with. Any last minute fall in value could hit the level of income you receive in the future - but similarly, any uplift after you retire is additional income you could be losing out on.
Unfortunately, none of us has a crystal ball and many people’s natural reaction is to put off making a decision. What many people don’t appreciate is that there are real costs associated with deferring too.
To help you make a more informed decision about whether to defer or not, we have identified below what we believe the 3 pertinent areas for you to be mindful of are and highlighted how they might affect you.
1. Attitude to Investment risks
Equity based investments are of course the most likely funds to be affected by short term movements in the markets. Within a short space of time, news flow and changes in sentiment can severely hit the value of shares and therefore pension funds.
To counteract this risk, as many people get closer to their final retirement date, they might start to transfer their money from equities into less volatile investments such as bonds or cash. This can help consolidate the gains made over the term of the pension and protects at least some of the fund against any last minute downturns.
However, even if they have taken this precaution, if they then decide to defer for a period of time, whilst the capital value in cash deposits is guaranteed, any long term holdings could suffer in real terms from the effect of inflation.
2. The risk of Annuity rate changes
Over the past ten years, the general trend in annuity rates has been downwards. This is basically the result of two factors:
- Increased longevity, meaning that pensions need to be paid for longer, reducing the amount available for a given fund value; and
- Lower interest rates, and bond yields, on which the pricing of annuities depends.
Whether this situation will change, particularly in the short-term, is as difficult to predict as it is for any market movement.
3. The value of income forgone
Finally, people need to be aware of the income they are giving up by deferring. The results can come as quite a shock.
As you get older, you actually become more likely to live even longer. For example:
- A male aged 65 today is expected to live to 86
- BUT a male aged 70 today is expected to live to 87
Based on Office of National Statistics Cohort Life expectancy tables, 2010
Hence, the amount of income you will be offered at various stages will not reflect a linear relationship. All other things remaining equal, therefore, there is a cost to deferral.
Mr Smith is aged 65 but does not need to retire yet. He is considering deferring until he is 68 as he wishes to work part time. He has £100,000 in his pension fund.
Assuming Mr Smith's fund grows at an average of 6% pa net of charges for 3 years while it remains invested, he will be £2,641 a year better off by deferring to age 68. That is 33% more income than the £7,847 he would be offered now.
However, over that same 3 year period, Mr Smith will NOT receive £7,847 a year. That amounts to a total of £23,541 in income forgone - not including any interest he might also have received if the money had been placed on deposit.
So, whilst Mr Smith may get a £2,641 uplift for waiting, he loses £23,541 (+ interest) that he would otherwise have been paid. He will therefore be 77 years old before he finally begins to actually make some of that money back.