Retirement planning is the first, and possibly the most important step in personal financial planning. Retirement planning involves determining major decisions which are necessary to realistically reach objectives over multi-year periods. In particular, how much you need to save and invest per year to reach your goals of comfortable retirement, home-ownership and raising children.
It is an essential first step for financial planning, because many of the subsequent decisions – on tax structures or ideal investment portfolios, for example – depend on your overall retirement plan. Defining “what is the best retirement plan” is not simple and can vary depending of your situation.
Follow the retirement planning checklist.
A comprehensive diagnosis of your personal situation, in terms of:
- Age and overall family situation: dependents & parents, etc.
- Profession, current and prospective income and associated risks
- Current net worth: savings and investment, property and debt and corresponding rates of return or interest
- Current and prospective expense levels: rent/mortgage, household expenses, discretionary and entertainment expenses, current and prospective dependents, interest and debt payments
- Personal preferences: are you conservative or aggressive when it comes to investments? Are you careful with your money or a big spender? And so on.
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A summary of your retirement objectives:
- What age would you like to retire at? (What is my retirement age?)
- At what standard of living? Would you like to maintain the same standard as you have now? Or do you look forward to retirement as ‘the holiday of a lifetime’ and would like lots of travel and entertainment? Or are you happy to down-size
- Would you like to retire completely at once or do some part-time work during your golden years?
- Would you like to leave an inheritance?
- What other major financial objectives do you have until then? Buying a home? A second one? Paying off the mortgage? Putting the kids through college?
A reconciliation of your situation with your objectives.
Given ‘where you are now’ and ‘where you would like to be’ at retirement, what would have to happen from now until then? Is that realistic? If not, what can be adjusted?
Quantitative documentation of the retirement plan.
This means putting your retirement plan into a spreadsheet projecting your income from work, income from investments, expenses, investment outlays and debt payments from now, through retirement, and all the way to your life expectancy, with hard targets against which you can monitor your financial progress.
This retirement plan implicitly relies on other aspects of financial planning, such as taxes and investments. Purely from a retirement planning standpoint, all you’d need to know is the average rate of return on your investments and how much tax you have to pay on each source of income. But in practice, these plans tend to go hand-in-hand and are prepared iteratively. For example, let’s say that based on your retirement plan, you’d need an investment return of 5% per year. However, looking at the sort of portfolio that could yield that return, you might find that it involves too much risk for your personal profile. So you’d rather plan on retiring a little later and saving a little more until then, in exchange for being able to have a more conservative portfolio.
In this sense, retirement planning is virtually synonymous with financial planning as a whole, and can be said to encompass investment and tax planning.
How does it work in practice?
William is 32 and single. He is a successful M&A partner in an international law firm. William is from the UK, working overseas in Hong Kong, making £200,000 per year, of which £150,000 is his salary and £50,000 is his bonus.
At first glance, William seems to be in a very comfortable position.
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William is wondering whether now might be the time to buy property in Hong-Kong, given a recent market dip, and decides he might as well discuss his overall situation with a financial and retirement advisor, who learns the following:
- William is engaged to Chloe, 28, who works as an auditor They would like to have 2 children, and ideally for her to stay at home and care for them. She currently earns £100,000 per year.
- William’s father passed away a few years ago. He had a business that didn’t do well and went bankrupt. So far, his mother, aged 62 living in the UK, has been living off some of their savings, but with £100,000 in the bank, and consuming £20,000 per year in addition to her pension, she will need help in a few years.
- William’s law firm gets much of its business from mergers & acquisitions in the finance sector. He chose to come to Hong Kong, rather than having been transferred to Europe, so although he has good health care, his firm wouldn’t pay for his children’s education in the future.
- So far, William has been in Hong Kong for 2 years. Chloe has been there for 3. They have been enjoying their cosmopolitan lifestyle, dining out several times a week and going on overseas holidays every couple of months. Neither of them have permanent residency yet.
- They currently share a rented flat that costs them £5,000 per month. As mentioned, William wonders whether it is time to buy.
- While William sometimes says that he’d like to ‘work until he drops’ and talks admiringly of the senior partners at his firm that are in their 50s, at other times it’s clear that his intense lifestyle takes its toll: he sometimes jokes about leaving everything and living on the beach, comments that his doctor recommends he exercise more and watch out for his high blood-pressure and reflects that many of those successful partners are divorced.
- William and Chloe, together, have £100,000 in savings. He explains that there were several years of hard work and low pay before their wages got to their current high levels, and that once they got there a few years ago, they hadn’t given much thought to saving, until now. They estimate their joint total expense level at £100,000 per year.
- William invests half his savings in an equity fund offered by his bank, and half in a bond fund. He wonders whether he should invest in some property opportunities that some of his friends at work have been discussing. Chloe keeps all of hers in a savings account.
As we can see, upon more detailed analysis, William’s situation isn’t quite as comfortable as it first appears. It is common for successful professionals to become accustomed with high incomes and complacent about retirement planning.
Having grown accustomed to a high standard of living, and facing the prospect of up to four dependents in the near future (a stay-at-home spouse, his mother and two children), with William’s job being significantly exposed to market risks, with limited savings as compared to their expense levels and unclear retirement goals, William and Chloe could easily find themselves in trouble down the line.
Importantly, William and Chloe have a tangle of objectives, concerns and questions – very few people have simple, text-book style retirement goals nowadays. In fact, it is interesting that retirement planning wasn’t even William’s primary concern – he was thinking about investing in property! A financial advisor plays an important role in helping organize these kinds of thoughts.
Anyway, his financial advisor runs some simulations.
Taking William’s finances together with his mother’s and soon-to-be spouse’s, they currently have £200,000 in savings, £300,000 in yearly income and £120,000 in yearly expenses.
Assuming that William’s income stays as it is until retirement at 60, that Chloe’s stays as it is until they have their first child in 5 years, that William, Chloe and his mother all live to 90, that they support their kids through college, that their expense levels stay the same (£100,000 between William and Chloe, £20,000 for William’s mother and £20,000 for each additional child), and that their savings earn real (after-inflation) returns of 1% per year, William and Chloe are in trouble!
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They can be expected to build up a net worth of £2.2 million by the time William retires, but that would not be sufficient to support their standard of living to the age of 90: by the time William was 84 and Chloe are 80, they would be bankrupt, and by the time Chloe is 90, she would be over £600,000 in the red. The situation could well be even worse: William’s mother’s expenses could rise as she ages and needs more assistance, high-end international schools in Hong Kong can cost as much as £28,000 per year during high-school, and William’s income could shrink as China-driven M&A business wanes.
Let’s assume, however, that William and Chloe make a few adjustments to their plans. They wait a little longer to have kids, allowing Chloe to work a couple of extra years. They also agree that once the kids are approaching their teens and in school most of the day, when the youngest is age 10, it makes sense for Chloe to go back to work – maybe not at her demanding auditing firm – but they reckon she could earn £40,000 per year.
William would retire later – at 65 – and Chloe would retire at the same time. But they think it is unlikely that he will be able to keep up such a demanding career that long. Of course, if things go well, he could make senior partner by the age of 40, which would mean a substantial increase in income, and then he might work until much later. But that is far from certain. So they forecast William’s income at its current level and assume that from 55 onwards he will choose a less demanding position and earn £100,000 per year. The plan can always be adjusted in the future, as situations change.
With this adjustment they’d retire 5 years later with a £2.6 million net worth, allowing them to live comfortably and leave an inheritance of around £300,000.
This adjustment was one of many possibilities that they discussed. Another alternative would have been to maintain their retirement ages but downsize their expenditure level at retirement, moving to a smaller home in a cheaper country. But William and Chloe would either like to retire in Hong Kong or in London – both expensive cities, and would rather work longer than forego travel and entertainment in retirement.
In addition to this, their advisor sees an opportunity to make some adjustments to their investments. While William’s allocation is reasonable, it is a waste to have Chloe’s and William’s mother’s savings in bank accounts. Even in William’s case, the funds he has have rather mediocre performance. By adjusting their portfolio to an allocation that is balanced between equities and corporate bonds, and choosing funds with good performance and low fees, he estimates they can reach an extra 0.5% return per year. While that doesn’t seem like much, it means going from £300,000 to a £1.1 million estate when Chloe is 90. Alternatively, it would allow William and Chloe to work less, retire earlier, have a larger home, keep their children in good schools, or have a larger buffer to protect against risks.
As for buying property – which was the original reason why William sought out advice – it becomes clear in the context of the retirement planning that it’s not something to do now, for a number of reasons. First, it’s best to wait to make sure how William’s income withstands the crisis. Second, investing in property would add the risk of a large and concentrated investment as compared to their total savings pot. Third, their advisor explains that Hong-Kong property is very expensive by global standards and that non-permanent residents face additional costs and bureaucracy.
In summary, William’s case illustrates:
- How, without planning, even well-off professionals can face retirement problems;
- How moderate adjustments can put you back on-track for comfortable retirement;
- How specific financial decisions, such as regarding investments or property, become clearer in the context of comprehensive retirement planning.
Could I benefit from retirement planning?
Yes. Everybody, regardless of age, income or net financial worth, can benefit from retirement planning.
For different kinds of clients, the recommendations might be different:
- For a middle-aged client approaching retirement with insufficient savings the conclusion might be that it makes sense to put it off for a few more years to ensure greater comfort during retirement;
- For a young client with a low income it might be to pragmatically adjust current expenditures and monitor savings in light of future challenges, or alternatively to seek out ways to increase their long-term income (such as through additional education or a career change)
- For clients with abundant savings it might focus more on optimising returns and taxes, ensuring that their investments are secure, and minimising inheritance tax on their estates.
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Each, in their own way, can benefit from retirement planning.
Can I plan my retirement alone or do I need an advisor?
If you have a moderate understanding of interest rates and spreadsheets, you can certainly do some calculations of your own. All you have to do is forecast your income from work, your income from investments, and your expenses (including tax, dependents, interest on mortgages and so on) all the way through retirement to a generous life expectancy. When it comes to investments, there are providers such as Hargreaves and Landsdown in the UK that offer some information and a variety of off-the-shelf funds to choose from. Prudential, Aegon, Best-invest, Axa, OMI, Friends Provident are other leading names in retirement products.
Having said that, working with a financial advisor providing free retirement help is highly recommended, for a number of reasons:
- Retirement planning extends beyond simply choosing retirement plans for individuals. As we have seen, it is the basis for all of your financial planning, which includes tax planning and investments of all kinds, even in real assets such as property. No two people are alike, so for a more comprehensive retirement plan, you really need custom advice.
- Although personal retirement planning is, in essence, quite simple, there are many details to consider. Proper qualifications, experience and expertise do help, and a professional is less likely to overlook details or make mistakes. The financial planner will help you compare the best savings plan for retirement corresponding to your situation.
- Tax rules change from year to year, and market rates and returns change constantly. In addition to that, the array of possible jurisdictions, tax structures and investment funds is very wide. Professional advisors have access to more complete and up-to-date information, and can allow you to make better-informed choices.
- In any case, two sets of eyes are better than one. Carrying out some research and doing some calculations of your own and then discussing that with your advisor and, on the other hand, reviewing and understanding their calculations is the surest way to a solid and realistic plan.
- Because retirement planning ultimately involves your entire net worth and income over several decades, which adds up to a substantial amount of money – even small adjustments and improvements can have very large financial effects. We saw above that a 0.5% increase in returns added hundreds of thousands of pounds to a family’s retirement funds over time.
- Proper retirement planning takes time, especially when you consider the time needed to research tax and investment options. It also required periodic reviews. And while it is ultimately rewarding, for most people, it is not a particularly fun activity. So you probably have better uses for your time.
- An independent financial advisor can ‘keep things real’, by putting overly-optimistic expectations in check and highlighting decisions that must be made or issues that must be dealt with, while at the same time providing calm and reassurance when meeting your objectives seems difficult.
When should I start?
As soon as possible. Because it is a certainty that we will all age and pass away, there is no reason to wait to start your retirement planning. Even if you are at the beginning of your career and your future income and family plans are uncertain, basic planning can help you understand the implications of various life-choices and guide your decisions and is an excellent habit to start early.
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Conversely, if you are approaching retirement, while one cannot go back and change the past, there are still adjustments that can be made to your current and future spending, investment portfolio and retirement age that can have a substantial impact on your comfort in retirement.
What are the risks?
While specific investment decisions can involve risk, retirement planning is absolutely risk-free, which is why financial advisors recommend it as a ‘no-brainer’.
But because retirement planning decisions can have long-term impact, do make sure, if you choose a financial advisor, that you are working with someone that is qualified, experienced and trustworthy, and, if required in your country, properly accredited.
What are the regulation?
In certain jurisdictions, the activities of financial and retirement planners are regulated. The regulations vary from country to country, but usually involve some of the following points:
- They have to pass certain knowledge tests.
- Their firms need to have their finances in order and report them to the regulator.
- They must disclose how they earn their fees (directly, through commissions paid by investment providers, etc.).
- They have restrictions on the kinds of fees they can charge.
- They face restrictions on the kinds of products they can recommend.
The retirement products themselves are also regulated. Offshore products will be regulated by local regulators.
How to get started with retirement planning?
To get started, you can either start by thinking through some of the points mentioned above, doing some calculations and researching some retirement products (such as those offered by the providers we mentioned above) on your own, or you can contact a financial advisor right from the very start.
As mentioned, you should ensure that your advisors are qualified and trustworthy. One good place to start is asking for recommendations from colleagues in a similar financial situation as you. Local regulatory bodies or industry associations of financial advisors often have directories of accredited advisors. PlanYourFinances.com, the website that provides this guide to retirement, also has consultants whom you can contact for custom advice.
Retirement planning is the core of personal financial planning because it comprehensively covers your financial objectives all the way into retirement. It should be the basis from which you build your tax and investment planning, and against which you measure your performance periodically. Everybody should do it, starting as early as possible.
While at its core it is simple, because of its breadth, it involves many details and has implications for very large sums of money. Because of this, even if you are financially savvy, it is ideal that you discuss your retirement plan with a financial advisor to make doubly sure you are on the right track. Adequate retirement planning can be critically important in allowing you to retire comfortably.
Next, find out how to optimise your UK Pension: Download our UK Pensions Guide.