Why do you need a decumulation solution?

Key takeaways

• While accumulation focuses on growing wealth over the long term, retirement requires turning savings into a sustainable income. This introduces new challenges around how long a pension pot will last and the income it can support.
• Successful retirement planning requires managing longevity risk, inflation risk, and sequencing risk. These factors can significantly affect the sustainability of a client's retirement income and long-term financial security.
• Poor market performance early in retirement can have a lasting impact on a pension pot, even if markets recover later. A well-designed retirement strategy should help clients navigate market volatility and improve income sustainability.

Building up a pension pot (accumulation) has risks; people need to accept and navigate market volatility, but the longer people have to retirement, the more they can afford not to worry about short-term market movements and benefit from “averaging in” over years.

Taking a sustainable retirement income from a pension pot (decumulation), has different risks. Normally, people are using savings rather than adding to them and time horizons are shorter. What matters then is how long will a pension pot might last when taking a given income.

Back to basics - what's important for retirement?

There are three key risks that need to be navigated to ensure a client can look forward to a comfortable retirement

• Longevity
• Inflation
• Sequencing

Longevity risk: Nobody knows exactly how long they will live. Fifty years ago, people could expect to live approximately 13 to 18 years in their retirement, now it is between 20 and 30 years. For the first time in history, the UK has more people over 65 than under 16, and the proportion of over 65s is forecast to rise from 19% today to 25% by 2045; by 2035, the population of people over 85 years old will almost double (ONS). When taking an income, people need to have some reassurance about how long their pension savings are likely to last for a given level of income.

Inflation risk: Everybody knows the cost of living has increased significantly in recent years. An inflation rate, around the Bank of England’s target, of 2.5% means that a client’s cash will lose roughly one third of its purchasing power over 15 years. £100 buys less than it did 15 years ago. Retirement investment strategies clearly need to have a degree of inflation resilience.

Sequencing Risk: If markets fall early on when a person is taking a pension income, a desired level of income becomes a greater percentage of the pension pot. This can have a lasting impact on how long pension savings will last, even if markets perform better later. The sequence of negative and positive returns matters for the sustainability of income taken from a pension pot. Retirement investment strategies need to be able to cope with market volatility and sequencing risk.  

Why do you need a retirement strategy?

Retired people need to be able to take an income from their pension post and have confidence about how long their pension pot might last

Assumes 8% drawdown in each of the first 4 years of retirement followed by 5% annual gains for the following 21 years.
*Assumes 5% annual gains in first 21 years of retirement and then 8% drawdown for years 21-27. Withdrawal rate of 5% taken from pension each year, increasing in line with inflation.

Source: W1M.

The chart above illustrates sequencing risk in retirement and shows how the timing of market returns can have a significant impact on the sustainability of a retirement income. Two clients start with the same size of pension pot and take the same income as a percentage (5%) of the pot. The black line shows what happens to someone retiring with a £500k pension pot but their retirement coincides with markets falling in their first four years, followed by positive returns for the next 21 years. The teal line shows someone who started with the same size of pension pot, taking the same 5% income level, but was luckier with their retirement start date and had 21 good years before a “bear market” for the last four years. The pensioner who happened to retire just before a period of market weakness could run out of money by the age of 81 but the retiree starting just before many good years in the markets might see their pension pot last until they are over 90. Retirement income strategies need to help people achieve greater income sustainability in different market conditions.

Our approach

Our solution repurposes our existing track record and expertise.

Glossary

Longevity Risk: The risk of outliving your pension savings due to living longer than expected.

Inflation Risk: The risk that rising prices reduce the purchasing power of retirement income and savings over time.

Sequencing Risk: The risk that negative investment returns early in retirement reduce the sustainability of income withdrawals and the overall lifespan of a pension pot.

Sustainable Retirement Income: An income level that can be maintained throughout retirement while balancing withdrawals, investment returns and changing living costs.