In last week’s post, I looked at the rule of thumb for retirement income, and concluded that 2.7% of your retirement savings might be a sensible starting point, but it doesn’t feel like very much!
The good news is that it is possible to increase the amount you can withdraw over and above the standard rule of thumb.
There are two things which can help you to withdraw more from your savings:
-An understanding of your expenditure, and, in particular, knowing how much of your expenditure is unavoidable.
-Some basic knowledge of investment markets, and, in particular, a knowledge of how close asset prices are to all time highs.
This knowledge can be used to help you to increase the amount you can withdraw from your retirement savings, without increasing the risk of running out of money. Here’s how.
Understanding your expenditure
Your outgoings can be broken down into two major categories:
-Unavoidable expenditure. This includes council tax, utility bills, fuel, basic food and clothing.
-Discretionary expenditure. The rest! Holidays, going out, non-basic food and clothing.
There is a grey area between the two types of expenditure and a luxury for one person may be a necessity for another.
Items can also move from being essential to discretionary and vice versa. I claim that I could live without a mobile phone; my children claim that they don’t need a land line!
Studies of spending in retirement have shown that the two types of expenditure change in different ways throughout retirement.
Unavoidable expenditure increases, more or less, in line with inflation every year. Discretionary expenditure tends not to; on average, it increases more slowly than inflation, and our experience shows that the frequency of discretionary spending reduces as retirement progresses.
In the early years of retirement, three or four holidays is not unusual, but in later retirement, one or two, more expensive holidays is often the norm.
The retirement rule of thumb assumes that you increase the amount you withdraw every year, in line with inflation. It works well for unavoidable expenditure, but it is too cautious for discretionary expenditure.
Most of us can cover all, or, if not, most, of our unavoidable expenditure through guaranteed income sources, such as the state pension, company pensions, and annuities. So, our retirement savings don’t have to be used to cover unavoidable expenditure. And, as a result, we can withdraw more than the 2.7% rule of thumb.
Research has shown that, if we are prepared to adopt a flexible spending strategy in retirement, we can increase the starting amount that we withdraw by 1% per year.
But what’s a Flexible Spending Strategy?
Taking a flexible spending approach means that you are prepared to reduce the amount you spend in some years, depending on the returns your retirement savings have achieved.
So, if your pensions and investments have had a poor year, you might not increase the amount you withdraw in the following year in line with inflation; you might even reduce the amount you spend in the following year.
Clearly, this approach won’t work for some types of expenditure (I doubt the local council will agree to a reduction in your council tax if the stockmarket goes down!); but you could decide to put off the third holiday of the year or go to Europe instead of Australia.
Adopting a flexible strategy can give a substantial boost to the amount you spend, increasing year one spending by as much as one-third.
Some research has shown that withdrawals that are targeted to be higher in early retirement, but then reduce significantly in later retirement, could give you an even higher starting income.
Knowledge Of Investment Markets
It is possible to increase the amount you spend if you have a knowledge of investment markets. You don’t need to be Warren Buffett though! You just need some key information, which is easy to obtain.
The rule of thumb is based on historic data. The withdrawal rate used for the rule of thumb is low enough to ensure that some of your original retirement savings will still be left at the end of 30 years; in the UK, the rule is based on a period including the First World War and the Wall Street Crash.
It follows, therefore, that, if you experience better investment returns than the worst returns that have ever been recorded, you can safely withdraw more than the rule of thumb. When markets are low, you should be able to add 1% to the starting withdrawal rate, when they are neutral, 0.5%.
Comparing the value of the assets in your portfolio to their highest ever value will give you an indication of whether values are low, neutral or high.
One More Way to Increase Your Retirement Spending – Get a Good Adviser!
We know that you should reduce the initial withdrawal rate by half of the annual charges deducted from your portfolio and our 2.7% rule assumes annual charges of 2% per year. A good adviser can reduce the amount you pay in charges – so you can spend more!
Tax can also have a significant and obvious impact; reducing the amount of tax you pay increases the amount you can spend. A good adviser will put a strategy in place to minimise the amount of tax you pay.
So, if your adviser can reduce charges and tax, you can keep more of your money you get to spend.
As well as analysing your expenditure and knowing the relative value of investments, we at Informed Choice think we are pretty good advisers! We can not only help you to plan your retirement successfully, but we can use our knowledge and experience to give you more money to spend when you stop work.
Happy Christmas!
