Investing for a 100-year life: putting it into practice

Important information - the value of investments and the income from them can go down as well as up, so you may get back less than you invest.

This chart is the output of a month-by-month model we have put together for an imaginary 60-year-old who is making a plan for the next 40 years. Let’s call him David. The blue bars show David’s income (left axis) and the orange line is the cumulative value of his pension pot (right axis).

This is what we assumed about David:

• He will work until he is 65
• He earns £6,000 a month after tax, and this rises in line with 2% inflation until he retires.
• He saves 10% of his net income (as he pays it into his pension out of gross income, it is increased by 25% for the sake of this model).
• At 65, he stops earning and he stops paying into his pension.
• He takes a state pension from the age of 67. This benefits from the triple lock and rises at 2.5% for the rest of his life.
• He has a defined contribution pension pot worth £1m at the age of 60.
• He grows his investments at 5% a year after costs.

This is what David says he wants to achieve:

• He wants to have an income for the first 10 years of his retirement that matches his final salary. After that he will cut his cloth accordingly.

This is what David is prepared to do in order to achieve this demanding goal:

• He is prepared to take significantly more out of his pension pot in the early years than the 4% rule would suggest is prudent. Our model shows that he needs to take 6% in order to match his final salary. And because he will be taxed on these withdrawals, we have increased the withdrawal rate by 25% (an effective 20% tax rate). He accepts that this is a risk.
• He is prepared to reduce his rate of withdrawal at the age of 75 to the standard 4% on the basis that his spending needs will be lower from that age. Again, assuming tax, this means a 5% withdrawal from the pot. He accepts that not only will he be lowering the withdrawal rate but it will be applied to a smaller pot due to his higher withdrawals over the previous decade.
• Furthermore, from the age of 80, he decides to stop inflation-linking his withdrawals. The state pension continues to rise in line with the triple lock guarantee but his withdrawals from his pension pot flatline from then on.

Does the plan work?

David’s income rises for 15 years in line with inflation and because his high withdrawal rate at retirement enables him to maintain his final salary - his principal goal.

The income then drops sharply at the age of 75 and the rate of inflation-adjusted growth slows five years later. You can see the change in trajectory on the chart.

The cumulative value of David’s pension pot shows a strong rise while he is still working thanks to a combination of market returns and his ongoing contributions. At retirement, the value of the pot starts to fall quite rapidly. At the age of 75 the rate of attrition slows significantly due to the reduced withdrawal rate.

Over time, David’s £1m pension pot rises to a peak level of £1.3m at retirement. It then reduces to around £900,000 after David’s decade of active retirement, and slopes away gently during his later years but crucially is still worth more than £700,000 if and when he makes his century.

Risks to the plan

David’s plan looks reasonable and achieves his goal of funding an enjoyable early retirement without unduly risking hardship in later life.

It is not without risks, however:

• The model assumes a 2% rate of inflation. If inflation runs higher than this, David will need to adjust his plans, perhaps significantly. Inflation can wreck long-term retirement plans.

Read: Inflation scenarios: what 3.8% rate does to a pension

• It is assumed that the triple lock will remain in place, allowing the state pension to rise by at least 2.5% a year. This may not happen in practice, given the state of the UK’s public finances.
• The model assumes a steady 5% investment return. While this is not unreasonable, it takes no account of sequencing risk. If David’s investment returns are poor in the early years, this could have a big impact.

Read: Make your pension last

It is worth pointing out that this plan is only possible because David had accrued a significant pension pot during his working life.

• See our current offers to help make your money go further

Final thought

One way to derisk David’s retirement plan further might be to consider buying an annuity at the age of 75 with what remains in the pension pot at that time.

Given David’s age, it is possible that he would be able to achieve a higher rate of return than the modelled 5% investment return, although the price he would pay for that security of income would be the loss of capital to pass on to any heirs.

• Read: Autumn Budget: inheritance tax and other possible changes

The Government’s Pension Wise service offers free, impartial guidance to help you understand your options at retirement. You can access the guidance online at www.moneyhelper.org.uk or over the telephone on 0800 138 3944.

Fidelity’s Retirement Service also has a team of specialists who can provide you with free guidance to help you with your decisions. They can also provide advice and help you select products though this will have a charge.

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