“How to deal with inflation risk in retirement”

I keep reading about how long people are living after retirement and wonder how on earth they manage to maintain a decent income throughout this time, what can I do?

People often think of their pensions as a bit like savings accounts. So they pay money in while they’re working, and when they retire they think they can take that money out, as and when they need it.

But that’s not actually how pensions work. For those that don’t have a “Defined Benefit” or “Final Salary” pension scheme the reality is that you will have to purchase a pension using your savings and someone retiring today at 60 can typically expect to live more than 20 years. So while having a long retirement sounds great, inflation can reduce the buying power of your money. For example today the average price of a loaf of bread in Britain is £1.19 it was a mere 65p 5 years ago and I’m sure there are plenty of similar examples here in Bahrain! So it’s important to consider inflation. So, can you imagine going 20 years without a pay rise?

Most retirees will place their savings in a mixture of bonds and stocks usually in the form of mutual funds or unit trusts wrapped into a savings plan which allows for access to a diverse range of medium and low-risk investments.

Some people start  this well in advance by saving on a monthly basis and perhaps adding a lump sum upon retirement; income is then obtained by withdrawing a percentage on a regular basis .The magic question is how much can you withdraw on this basis and still maintain the income for 20 years or more?

Many financial planners use a 4% approach; withdrawing 4% per annum should mean one could live happily ever after; but what if the stocks and/or bonds go down?

So, some would exercise caution and withdraw only 2% per annum, but for a decent income the pension pot has to be pretty substantial to say the least!

Others, more confident in growth rates, might plump for 6% withdrawal per annum.

Quite honestly there’s no easy but one thing is true and that is growth rates are not always straightforward, the crash of 2008 brought stock prices down and where someone is taking out a regular withdrawal this would mean selling units at low ebb, damaging the chance of decent growth during the recovery period.

So perhaps we need to have a flexible 2-6% approach -increasing the withdrawals when the markets are high and reducing them when there are low to help ensure that one’s long-term income can be maintained.