How much can I have from my pension – The Pension Equation?
We are often asked how much can I have from my pension. This used to be a fairly simple question. The vast majority of people generally used to take 25% of their fund as a lump sum and either buy an annuity or enter income draw down with the rest. The resultant income was broadly similar, and largely dictated by prevailing market rates.
Now with 2 months to go until pension freedoms, the simple answer is how much do you want?
How much you want and how much you need are unlikely to be the same. There will always be a conflict between these two figures and it is difficult to strike a balance between them. Individuals will each have their own thoughts on what is important to them. This is often reflected in an individual’s circumstances, experiences, beliefs and own requirements.
What is clear though, is that when considering the question “How much income can I have?” a few simple steps should be followed.
A starting point is to consider what we refer to as the pension equation. People need take a step back and consider what their Pension will provide them, initially based on the traditional methods. That is, what is the risk free income that can be achieved from the available fund, and is it sustainable for the rest of their lives? This can then be used as the starting point to explore further options.
The chart below distils this to 5 simple components which help you arrive at a suitable starting figure.
A sustainable income could be provided in a variety of ways, but the base factors and components are the same. It’s a bit like gravity. If you have a small fund and you want an income for 25 years, it is, sadly not going to give you very much.
However, if you want to use the fund to provide an income over say a 5 year period, until say a state pension or works pension kicks in, the number can change dramatically.
Short term people are unlikely to want any risk, but when looking at 20 year terms and beyond, it would seem reasonable to assume some appetite for investment risk which provides the potential for additional returns, thus enhancing the income available. Risk levels can vary, so can returns.
Alongside the 5 components there is a long list of other factors that need consideration. For example, is it important for your pension to provide an income for your spouse if something were to happen to you? Do you want to vary the amount of income you receive? What is your current tax position and how will additional pension income affect the amount of tax you pay? Is the pension your only source of income in retirement?
The list goes on and on!
Everyone’s position is different. What’s right for one person is not the best solution for the next person.
If you want to discuss your own equation, please contact us.