How will the retired be affected by the coming recession?
In my last blog post, I advised that the impact of the recession, if and when it takes place, will depend on which stage of your financial life you are in.
Those who have retired will worry more about the macro-economic impact – will they be able to generate enough income from their retirement resources?
If you are retired, you still need to consider its impact on the four building blocks of your retirement plan – expenditure, income, liabilities and capital.
The retired should consider the following:
Know your outgoings.
It’s essential to break down your outgoings into essential and discretionary items and make sure that you include the occasional items (like house maintenance and repairs for your car).
Many of our clients are reporting that their discretionary expenditure has reduced significantly as a result of coronavirus – overseas trips have been cancelled, and it’s harder to spend money on entertainment.
But over the winter, some items may become more expensive – electricity and gas as we stay at home more, and the cost of food has been rising too.
Any second period of lockdown may see many of us upgrading home communication equipment and buying better webcams to stay in touch with family and friends.
But it’s an essential first step to know what you have been spending money on, and which of these you consider to be discretionary, and which are essential.
Many more of our clients now consider their private medical insurance premiums to be an essential item of expenditure.
Understand your income sources.
In retirement, it’s essential to understand what income is guaranteed and what income may vary.
Your state pension, defined benefit pensions and annuities are guaranteed, with most other income sources dependant on returns achieved by investments. However, even guaranteed income can reduce if the tax payable on that income goes up.
It seems likely that, at some point, the government will need to raise taxes, and this could affect the amount you receive, after-tax, from these guaranteed sources.
But, if you make sure that you know how much you are receiving, before and after-tax, you will at least be in a position to know, in advance, how your income will be affected by any tax rises.
Review your liabilities.
Most people, in retirement, don’t have the traditional liabilities of mortgages and other loans.
However, many have unofficial liabilities, such as gifts to grandchildren (if you have made a gift to one grandchild, you may feel obliged to make the same gift to your other grandchildren, for example).
It’s essential to know what these unofficial liabilities might be and to include them in your financial plan.
Understand your capital.
It’s essential to make the distinction between liquid capital, which you can spend at any time, and illiquid capital (i.e. assets that it will take some time to convert to cash, like property).
That will help you to know how quickly you can convert your assets into spendable cash, should you need to.
We can see that the recession will have its most significant impact in the following areas if you are retired:
If the recession results in a reduction in the value of your investments, or a reduction in the expected returns from your investments, this is bound to have an impact on the amount of income you can withdraw, without the risk that you could run out of money.
Fortunately, technology has come to the rescue here – we can model the impact of a reduction in values or future returns.
We can review how likely it is that you will run out of money during your lifetime (based on the last 120 years of returns and inflation, taking account of your life expectancy and personal requirements).
This analysis should help you to decide whether you should reduce the amount of income you are drawing, or whether you should continue as you are (or even increase the amount you are spending).
The value of your capital is likely to be affected by a recession, but not in the most obvious way.
Recessions don’t always mean that capital values fall – the financial system is far too complex for that.
A diversified portfolio of shares, fixed interest stock, property and cash has worked well in previous recessions, so that’s the obvious solution this time around. It may be a bit boring, but it works!
It’s important to work out whether you will need to draw down on the capital, and when you might have to, and that should help you to determine your investment strategy.
To work this out, you’ll need to understand your income, expenditure and liabilities, and work out how much risk you are prepared to take. We think that it’s better if a Financial Planner helps you with this.
Knowledge of your capital, liabilities, income and expenditure will also help you to know if you can afford to help your children and grandchildren in the recession and what compromises you may need to make to help them.
As usual, the best approach is to make a calm and considered plan and to ignore those who will encourage you to make dramatic changes.