Your Retirement Salary tackles the knotty question of how to transform savings into income that will sustain you during your golden years.
Richard Dyson and Richard Evans are experts in personal finance who have responded to readers’ questions for a leading British newspaper for more than a decade.
You may be wondering if you should read the book. This book review will tell you what important lessons you can learn from this book so you can decide if it is worth your time.
At the end of this book review, I’ll also tell you the best way to get rich by reading and writing.
Without further ado, let’s get started.
Lesson 1: Selling assets can compensate for income shortfalls, but be careful
Assume David is a retiree with a $300,000 pension pot. His annual expenses are only $15,000 because he owns his own home. To meet his goal, he must earn a 5% annual natural yield on his investments. However, the market only gives him 4.24 percent. So he’s short $2,291 ($12,709).
David’s assets do not generate the necessary income, so he must sell some of his capital. Doesn’t that sound like the start of the end? Perhaps not. It’s critical to understand how much of your pension you can sell without getting into trouble.
When retirees cover their costs by selling assets, they run the risk of selling too many shares or fund units when their market value is either lower or higher than average.
Assume you need to raise an extra $500 per quarter to cover your deficit. You would have to sell 500 shares of a one-dollar-per-share fund. If the price fell to 90 cents, you would have to sell 555 shares.
This shortfall could be covered by selling those extra shares, but this would be unsustainable. The reason for this is that your share count has decreased. When you withdraw again, you are forced to sell even more assets.
It makes sense to sell income-producing assets when asset prices rise. If the price of those same shares rises by ten cents, you may be tempted to sell a large number of them. Although the windfall comes with a catch: fewer assets will generate income overall, forcing you to sell more later.
If you want to avoid these dangers, follow this rule: Each year, you should sell no more than 1% of your original shares or funds.
This translates into a 1% annual decline in income-producing assets. Furthermore, regardless of how well or poorly each fund performs in your portfolio, you should sell across the board. This removes the uncertainty of selling while also preserving the portfolio’s overall income-generating potential.
Lesson 2: Annuities can provide retirement income without risk
As you take an income and sell some of your capital, your pension pot will shrink. Our previous insight explained how to manage this process by selling no more than 1% of your income-generating assets each year.
If you know how long you will live, this method works perfectly until the end. Regrettably, you have no idea how long you will live.
As you get older, you are more likely to break down this system. The prospect of going without pay for an extra year is terrifying. That is why you require a backup plan.
Annuities can assist with this. Annuities are types of insurance contracts. In exchange for a lump sum, such as the amount in your pension pot, you receive an annual income from an insurance provider. Annual increases average around 3%.
Doesn’t that sound fantastic? The issue is that annuities are rarely a viable way to convert life savings into retirement income. The rate for 65-year-olds, for example, would be 2.8 percent. With a $300,000 pension pot, that comes to just $8,400 per year.
That changes as you get older. Healthy 65-year-old women live an average of 86 years. For insurance companies, this equates to 21 years. As a result, their rates are low. Every year that the expected lifespan is reduced raises the rate.
Assume you have a $100,000 pension. Your annual income at 65 would be $3,214. This would be $3,806 at the age of 70, and $6,015 at the age of 80. As a result, by your late seventies, you should be able to obtain an annuity that replaces the target income from your portfolio.
An annuity also has other advantages. Think about security. Annuity providers are required by law to meet their obligations. You can therefore relax. An annuity ensures your financial security regardless of what happens in the stock market or the economy.
Furthermore, you can rest assured that necessities such as food and bills will always be met. Furthermore, if you die before your partner, he or she will receive approximately half of your income.
Annuities also require little upkeep. Annuities, unlike portfolios, do not require active management. As a result, it’s a great option for older investors who don’t have the energy to keep track of their investments.
Lesson 3: Taking money out of your home to fund your retirement is risky and expensive
If you own a home, it is most likely your most valuable asset. Can it be used as a retirement fund? Usually, the answer to this question is “no.” Let’s look at why.
The process of borrowing money from your home is known as equity release. Essentially, you are “releasing” or “freeing up” the value of a property without actually selling it. Equity-release mortgages are typically available only to borrowers over the age of 55 or 60, so this is something that older people do.
Taking out a loan in this manner is a significant step. Your life’s work is essentially depleting the value of an asset that you’ve spent a significant portion of it paying off. If your children or other heirs inherit your home, this will have an impact on them. Equity releases can also be costly. Even though global interest rates have fallen, this is still an expensive form of debt.
When considering interest, keep in mind that it is compounded. As a result, you will have to pay interest on interest that you already owe. Consider borrowing one-third of the value of your home at a 6% interest rate.
Based on a 4% increase in house prices, your debt after 35 years would be roughly two-thirds of the value of your home. To put that in context, a $1,213,730 house would have $812,355 in debt.
Equity-release mortgages are costly, so they should only be used as a last resort. You should never borrow money in this way unless you have an emergency.
There are some restrictions on how much of a property’s value you can borrow. Your age determines the amount. Your limit is lower as you get younger.
To take advantage of this value, older borrowers must ensure that their contracts contain no negative equity provisions. Your bank guarantees that the loan amount will not exceed the house’s value.
Lifetime mortgages are the most common type of equity-release mortgage. As a result, you will pay a set rate for the rest of your life or until you leave your home. However, instead of making monthly payments, you pay down the interest every three years.
Lesson 4: Before leaving money to your heirs, consider what will happen to your assets after you pass away
It’s an uncomfortable subject, but we must all plan for how our assets and income will be handled after we die. You must understand this issue because it may alter your retirement planning, particularly if you want to ensure better tax outcomes for your heirs.
Pensions and annuities can be inherited by your designated heirs after your death. In most cases, depending on the terms you reached with your provider or employer, your spouse will receive half or two-thirds of your income. These arrangements have no immediate tax consequences.
Most assets are subject to inheritance tax. The procedure is fairly simple. After death, estates (the deceased’s total assets) are exempt from inheritance taxes. This portion of the estate is exempt from taxation.
In the United Kingdom, for example, the first $400,000 in inherited wealth is tax-free; married couples and civil partners can receive an exemption of slightly less than $800,000. The remainder of the estate is then taxed at 40%, the same rate as in the United States.
Pensions, on the other hand, are treated differently in many tax jurisdictions. Pension funds are partially protected, whereas inherited homes are typically taxed. Assume an 82-year-old woman living in a $1 million home inherits a $330,000 pot from her deceased husband.
If she wants to leave something to her two daughters, she should keep the pot intact, because her house is subject to inheritance tax regardless of what she does.
The word “partially” is important because there are complications. An inherited pension pot is not subject to inheritance tax in the United Kingdom, but it is subject to income tax. This is determined by the deceased’s age.
If they die before the age of 75, the beneficiaries of the pension pot will not have to pay taxes; if they die after the age of 75, the withdrawals by your heirs will be taxed at the same rate as their own income.
You should be able to start making your own plans now that you understand how pension planning works. As we’ve seen, you have several options. It is critical to combine them correctly and, whenever possible, to avoid major risks.
About the Author
Richard Dyson has won several financial journalism awards and writes for a variety of publications, including the Express, Mail on Sunday, Investors Chronicle, and the Daily Telegraph. He was also the Telegraph Media Group’s head of personal finance.
Richard Evans is a well-known financial commentator, savings expert, and investment analyst in the United Kingdom.
He has spent years researching the industry and conducting hundreds of one-on-one interviews with the top fund managers and investors in the United Kingdom.
Buy The Book: Your Retirement Salary
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