You’re looking to find out how much money you’ll get from your pension; to work out when you can afford to retire.
So finding an online pension forecast calculator would seem like the logical thing to do.
Calculators are very useful tools that can help you plan your retirement. But you need to be careful.
It’s very tempting to gather up all your papers, spend 30 minutes or so entering in the details into a beautifully designed form. All you need to do is move around a few sliders and – hey presto – out pops the answer to how much you’ll get every month when you quit the rat race in five or ten years’ time.
The results you get will feel very convincing, and you might even be tempted to get right on the phone to start taking action. Here’s the issue though.
The answer you get will be correct (providing of course the calculator is a good one) for the data you’ve entered and the calculation you’ve done. But are your assumptions right? Have you even done the right calculation?
Here are five reasons why a pension forecast calculator could lead you into troubled waters. Why it could even kill your retirement.
1. Size isn’t everything
How much you manage to save into your pension (or pensions) during your working life is critical. After all, if you haven’t built up a certain level of wealth there’s just no way that you’ll be able to fund a comfortable retirement.
However, the way you access your pension will have a huge impact on the income you’ll receive. You can get very different incomes depending on the decisions you make with respect to withdrawal.
Following the liberalisation of pensions in 2015, you’ve now got near total flexibility on how much you take out of your pension, and when.
The problem is that pension forecast calculators generally use some pretty simple modelling to forecast the income you’ll receive from a pension pot of a certain value. They force you into a “one size fits all” approach that doesn’t take your personal circumstances into account. They don’t help you think through the best way to exploit your freedoms and how to maximise your income from your assets.
There are also some new options to consider if you have a final salary scheme, including turning this asset into a cash value and tapping into it flexibly rather than taking a regular increasing income. Calculators generally can’t cater for this type of option.
2. Investments are full of risk
An online calculator will probably encourage you to set a single assumed growth rate for the whole of your portfolio, and for the entire period between now and your retirement. Further, you’ll probably be guided to choose one from a selection of high, medium or low investment rates of return.
But that’s not how your funds grow.
There is inherent uncertainty in fund growth rates. The more risk you’re willing to accept in your investments, the broader the range of outcomes your portfolio could deliver. And that spread gets wider over longer time periods.
Even with lower risk profiles where returns are more predictable, other factors like inflation rate assumptions come into play making your forecast income uncertain in the long term.
Pension forecast calculators report your likely income as the average return.
You could get more, or you could get less. How much more or less depends on the level of risk in your investments.
It’s not possible to make sound planning decisions on the basis of simple forecasts using average returns. You need to think about what life would look like across the range of outcomes and be happy you could live with any of these.
You might also want to consider exposing different parts of your portfolio to different levels of risk. Money that you want to access in the near term might be better held in cash (low risk) whereas longer term investments might be able to withstand more risk.
3. How much tax you pay is important
Tax has a huge impact on how fast your retirement savings grow AND on how much income you get to spend in retirement. That’s kind of obvious. I know.
But knowing how to reduce the amount of tax you pay isn’t that obvious. In fact it takes a lot of knowledge and years of experience to be able to plan someone’s retirement finances in a tax efficient way.
You don’t get that with a calculator.
Take for example a man who I consulted with just this morning. He has a fund of £200,000.
By crystalising only £40,000 of his fund he can take £10,000 of that as a tax-free lump sum into cash, withdrawing £400 a month for the next two years or so. He’ll leave the remaining £30,000 invested in a drawdown plan providing £900 a month. He’ll still have £160,000 in his pension growing tax efficiently for the point when he needs to top up his cash. As this will still keep the gentleman’s income below the personal allowance, he can take a total of £1,300 a month tax-free. A calculator would not assume this strategy.
There are many other opportunities to reduce the tax you pay on your retirement income that calculators won’t normally factor..
The picture provided by a pension forecast calculator could encourage you to save more than you need in order to compensate for the unnecessary tax it says you need to pay. Or you might even delay retiring if you think that you can’t afford to retire sooner.
4. Planning is one thing. Delivery is something else.
Planning your retirement at the outset is one thing. It’s quite possible to “run the numbers” and get an indication of what your income will be when you retire.
Calculators make you think that the process ends there. You just keep making regular contributions into your pension until you finish work and then start taking an income.
But situations change. Interest rates go up and down, as do investment returns. So too do your spending plans.
Keeping up with these changes and making sure your plans stay on track is vital.
It takes a lot of time to compare your investment funds’ performance against its peers, to rebalance your portfolio and update assumptions.
Without regular oversight, what you actually get to take as an income in retirement could be much lower than that which you forecast using a calculator.
5. Interaction between assets
Forecasting the growth of your pension fund over time is important. And you are right to do so. It’s an important part of the planning process.
However, recognise that your pension fund is just one of your assets. ISAs, property, inheritances and possible proceeds from a business sale should all be factored into your retirement plan as each can produce an income for you.
Forecasting your pension income alone doesn’t give a full picture.
If you’ve got sufficient wealth, you might even leave your pensions untouched. Subject to certain allowance restrictions, you’re pension can be passed onto your beneficiaries free from inheritance tax. Using other assets to fund your retirement could be beneficial.
Calculators cannot advise you on which assets you would best use to generate your retirement income.
So, 5 reasons why a pension forecast calculator can give you the wrong answer to how much income you can expect to receive in retirement. That’s not bad in itself, but if you rely on the high level answer you get after plugging in your details you could find that you lose a ton of money either to your pension provider or to the tax man.
What would I suggest? Get some human advice to help you make get the income you need, to pay less tax and preserve your wealth for the kids.