Options, risks, and returns for an early retirement.
If you wish to retire at 55, at least a decade earlier than most people, you will need a much bigger-than-most pension ‘pot’. Currently, average UK life expectancy for 30-year-olds, across both females and males, is around 81 years. That means a 55-year-old retiree should have enough to fund their expected lifestyle for at least 26 years, compared with 16 years for someone aged 65.
You could live passably on half of your final salary at retirement. Very likely, that would require unwanted economies. For a comfortable retirement, it’s advisable to aim for a pension equal to at least two-thirds of final salary. In the UK, that salary is about £37,000 at age 55. How much savings must you have to yield £24,400 annually for at least 26 years?
Consider independent financial advice
Although early retirement is a lifestyle choice it’s a decision based on your personal finances. The earlier you choose to retire the longer you will need to support yourself without a salary.
Independent financial advice from a company like Hartsfield will help you to understand the facts of your financial circumstances whilst creating a long-term plan. Also consider at look at Unbiased who recommends over 27,000 restricted, independent advisers.
Pay me my money down
The answer largely depends on how that income will be paid. Since the Great Financial Crisis (2007-08), a strong housing market has made buy-to-let residential property an increasingly popular choice for retirement saving.
That approach entails significant risk. House prices can suffer declines and, if repeated at or close to retirement, the approximately 20-percent fall seen in 2008-09 could prove disastrous to the value of pension savings.
Risks aside, with yields on UK residential property averaging about 3.5 percent, a £700,000 BTL portfolio would provide an income of some £24,500 annually.
A balanced portfolio of equities and bonds yields about the same. It also has lower costs, but, as the next two charts show, listed securities have experienced significantly higher price or return volatility than residential property. That may continue.
The end of the line
Another option is income drawdown. Rather than live off investment income, the retiree conducts regular sales of portions of their portfolio (property, listed securities, vintage watches, art, or whatever) to fund spending.
This combines the worst of the risks and costs described for the other two options, but adds a few of its own. At least, with the previous approaches, the pensioner retains their pot which, on death, can be passed to a surviving spouse or children.
Income drawdown not only undermines that but is subject to market risk for each sale. Sometimes, strong prices may mean selling less to provide the required income. Equally, prices may fall, requiring a bigger chunk to be sold.
This approach also means your pension is finite. At age 83, after drawing down £24,500 each year, a £700,000pot will be nearly exhausted. What if you live longer?
Ultimately, the financial drawbacks of these options matter less than their possible effect on peace of mind. No matter how much we love our work, the great majority of us look forward to a time when we cast off the stresses, strains, and responsibilities of our careers.
You may have happy plans for that time: playing with grandchildren; finally setting out the garden the way you want; voluntary work; restoring the classic car that’s been sitting in the garage for years; and so on.
These are the deserved of someone who no longer has to worry. If they are funded by property income or periodic market transactions, you will spend time scanning the financial pages, dealing with tenants or intermediaries, and arranging disposals.
For some, that will be enjoyably engaging and purposeful. For others, the path taken to build their pot will have been worrisome enough. They want their pension to be hands-off and worry-free. They might be candidates for a lifetime annuity, therefore.
For payment upfront, it could provide a regular, preset, inflation-protected, and guaranteed income for life. You can bequeath any balance left, either as income or lump sum.
That security bears a high cost, however. Currently, with a guaranteed yield of barely two percent, some£1,225,000 is needed to provide £24,500 annually.
So, how much do you need to retire at 55? For three of the four options outlined here, the answer is: about £700,000. Annuities, the fourth option, may provide fewer anxieties, but at substantially higher cost.
The devil in disguise
Such barebones analysis skates over the details – where, of course, the devil lies. We haven’t calculated the effect of becoming eligible for the state pension at age 66 to 68, depending on date of birth, nor of the impending 2028 increase in the ‘pension freedom’ age from 55 to 57.
And what happens if you have to move into care?
Above all, the returns outlined here are based on averages. Some wit once likened those to having your feet in the oven and your head in the fridge. On average, you should feel comfortable. Clearly, that’s nonsense.
Before taking any decisions on your retirement, therefore, speak to a professional adviser.