BY JOHN ELLIS, FINANCIAL ADVISOR
When we come to pension provision we concentrate on the growth of a fund to prove an income after retirement for the rest of your life. This in itself is a challenge as you are required to navigate the vagaries of the pension realm; investment strategies, fund choice, risk analysis, de-risking, contributions levels, inflation to name but a few. The technical term for this process is called accumulation.
But when you are facing retirement you are looking at a new set of challenges. Having matured your pension and taken your tax-free cash the task is converting your remaining fund into a reliable income stream that will hopefully last for the rest of your life.
This process is known as decumulation, and it’s an important aspect of retirement planning that has often been neglected and has become more complex.
Back in the day there was little freedom in managing your pension. You saved into usually a ‘with profit’ pension fund, and later unit-linked funds, as today and when you came to retirement you were required after taking your tax free lump sum to purchase an annuity at whatever rate was available at the time. You had no choice, it was one size fits all, in effect giving control of substantial sums of money accumulated over a lifetime to pension providers for a guaranteed pension for life.
For some that was exactly what was required, a regular guaranteed income. But there were many who resented this one option only and felt they should have control of their capital, invest in a way of their choosing and be able to decide how and when to access the fund. Then came the Approved Retirement Fund (ARF).
But with the freedom attaching to the ARF came decumulation. People now had to start making choices about when and how to withdraw money from their pension pot, what kind of investments to hold, and especially how to manage risk, market volatility and longevity.
As with all things financial there are several different approaches to decumulation, each with its own advantages and disadvantages. As outlined above, continue to rely on an annuity, providing a guaranteed income stream for the rest of ones life with no worries of the fund running out. The other approach is to use a methodical withdrawal strategy with the ARF, which involves withdrawing a fixed percentage of retirement savings each year.
At retirement, depending on your age, you have to take a certain percentage of the fund each year, starting at 4%, rising as you get older.
A more flexible approach than an annuity, but requires you to manage investment risk and ensure that your withdrawals don’t outpace the pot of money you have.
Decumulation requires careful planning and ongoing management. You need to consider inflation, changes in taxation law, and changes in your personal circumstances.
You will also need to consider how to manage risks such as market volatility and the big unknown, how long will you live after retirement.
All these factors having a serious impact on the success of your retirement income plan.
One important aspect of decumulation is working with your financial advisor who can help you develop a plan that takes into account your unique circumstances and goals. The advisor can provide guidance on investment strategies, withdrawal rates, risk management, also helping you navigate the complex tax and regulatory environment surrounding your retirement.
In retirement you need to choose an approach that meets your income needs, while also managing risk, ensuring your hard won pension pot will last for the rest of your life. By working with a financial advisor and staying informed about changes in the retirement landscape, you can develop a decumulation plan that provides peace of mind and financial security in your golden years.