Why are you still working?
I’ve lost count of the number of times I’ve met a potential client and, after a little fact-finding, asked the question: “Why are you still working?” I reckon it is nearly as many times as I’ve had a look of disbelief accompanied by the reply “What do you mean?”
The reality is that, in my experience, the average well-paid individual spends too many years working and thereby accumulates more liquid assets that they will never be able to spend over the rest of their life. Of course, these excess funds can be cascaded down through the generations but, with a little financial planning, the option of retiring earlier or working part-time may have been a more attractive proposition than the creation of a legacy to many.
Employment is a comfort blanket that can be difficult to shed so, once I have explained my reasoning to the surprised client, we can get around to discussing why they have not taken the leap into retirement or at least an easier way of living. In most situations, the principal reason for indecision is fear and that fear is generated from a lack of knowledge or understanding of what their wealth can generate as an income.
A major contributor to that indecision is that, in the last couple of decades, there has been a paradigm shift from final salary pensions which delivered a definite income in retirement to money-purchase pension arrangements. The introduction of pensions freedom which allows unrestricted access to the money-purchase funds and the current unpopularity of the annuity primarily due to low-interest rates have further added to the uncertainty that affects those considering their possible retirement.
In order to unlock this indecision, the potential retiree needs to understand what income they will need in retirement and the first mistake is to equate this to their current salary which has been taxed at source. Retirement income can be drawn from many sources and, with a little ingenuity, can be largely tax-free.
Income drawn from a pension is a prime example as 25% can be taken tax-free and the remainder is taxed at the marginal rate. So, if the individual is a Basic Rate taxpayer (20%), the effective tax rate on withdrawals becomes 15% assuming the tax-free lump sum has not been drawn at outset. When the Personal Allowance is factored in, the Income Tax on drawings of £40,000 pa is only £3,500 or 8.75%. On £30,000 pa, it is only £2,000 or 6.67%. In addition, there is no National Insurance on pension withdrawals.
Income can also be drawn from other pots and, if the Basic Rate threshold is not exceeded, other allowances will come into play. For instance, in the case of cash/interest, there is a Personal Savings Allowance which means that the first £1,000 of interest is tax-free; for general investments/dividends there is a £2,000 dividends allowance. Thereafter, Basic Rate taxpayers only pay 7.5% tax on dividends. Drawings from ISAs are, of course, tax-free.
Another factor which is often missed in retirement planning is the cost of convenience for the employed – holidays taken at peak time, cost of travel, lunch, Costa breaks, work clothing, convenience shopping, dog walkers etc. All these drop away in retirement and will be replaced by an obsession with bargains – switching energy suppliers, sale shopping and 2 for 1 lunch offers in the case of my friend Voucherman Dave. The net effect is that the headline income that most think they will need in retirement is actually much less as is the asset base required to support it.
So how much do you need to retire? A simple rule of thumb is to add up your total liquid asset base – pensions, cash, investments, rental properties and equity that could be released if downsizing the home is part of the plan less any debts. Then divide that figure by 100 minus the expected retirement age so, for someone who is 55, 100 - 55 = 45. If the resulting figure gives an annual income which would allow you to retire, it is worth looking into it further.
The next logical step should be a retirement planning interview. Everyone has an interview before they start a job so why would you not want to go through a similar process at the end of a career bearing in mind that, after a period out of the workplace, retirement can become an irreversible decision? The interview would include a complete cash flow analysis looking at assets, expenditure, tax, risk and a walk through disaster scenarios such as a market crash. If the outcome is positive, it will probably take at least another year to 18 months to become fully committed to the process.
Even then, there are many that carry on working either because they like their jobs or they haven’t yet joined the right golf club. For those, there is the solace that, when they’ve had a bad day in the office, they can ask themselves the question: “Why am I still working?”