A new report from Hargreaves Lansdown reveals 90% of households can cover their expected essential spending in retirement with a combination of the state pension and an inflation‑linked annuity purchased using their pension pot.
Analysis of key data show almost all low earners (95%) can cover their expected essential spending. This figure falls to 87% for high earners.
Spending declines as people go through retirement. The lowest income quartile sees an estimated spending decline of just 2.1% between the ages of 65-74 and 75-87; 5.3% among higher income quintiles.
Spending declines over time are also higher for couples than for single households, due to their ability to scale back discretionary spending and share essential costs.
Choice of retirement income strategy plays a huge role in helping people maintain their spending and give them the flexibility they need.
Hargreaves Lansdown has published a thematic report called Retirement Spending and Planning alongside Oxford Economics.
This report estimates annual spending for retired households based on a range of demographic and financial characteristics. The modelling draws on the Living Costs and Food Survey (LCFS) dataset, which provides spending patterns across birth cohorts of retired households. The Wealth and Assets Survey (WAS) is used to assess the proportion of households that can afford the predicted retirement spending based on their pension wealth.
The pension pot required at retirement to fund each household’s expected spending can then be estimated. This is based on their modelled retirement expenditure, the chosen decumulation strategy (e.g. drawdown or annuitisation), and the need to cover both spending and any tax liabilities. These results are then compared with the level of defined contribution wealth in the HL Savings and Resilience Barometer data.
Helen Morrissey, head of retirement analysis, Hargreaves Lansdown:
“How much is enough to live on in retirement? It’s a question mired in mystery and the worry of falling short puts many people off engaging with their pensions. But our latest analysis shows nearly 90% of households will be able to cover their essential spending in retirement. This includes elements such as rent or mortgage payments, food, clothing and essential travel. It’s based on someone getting a full new state pension and purchasing an inflation linked annuity with their pension. It’s a message that will be greeted with a sigh of relief by anyone worried their retirement planning may be falling short.
That’s not to say there are no flies in the ointment. The state pension continues to do much of the heavy lifting when it comes to pension adequacy. If you were to remove it from the data, the proportion of households expected to meet their essential spending falls to just 42%. It’s clear that the state pension forms the very foundation of our retirement income and much more needs to be done to encourage individuals to put more into their pensions. Put simply, if you want a retirement filled with more than just the essentials and maintain your quality of life then you will need to put more into your pension. It’s also a question at the very heart of the government’s work on pension adequacy.
Spending patterns change over time
How we take an income in retirement is just as important as the savings phase when it comes to retirement. Understanding how spending patterns change is key. The analysis shows that spending in retirement declines over time. This is fairly modest for those on the lowest incomes with average expected spending declining just 2.1% between the ages of 65-74 and 75-87 for the lowest income quintile. This is a shift from around £19,400 per year to £19,000.
The decline is more marked among higher quintiles, as they have more room in their budgets to cut back on the nice-to-haves. The analysis shows those on the highest incomes saw a 5.3% fall from around £65,900 per year to £62,400.
There are also major differences when looking at the difference between single and couples, with couples seeing the largest declines in average spending. Again, this is due to there being more room in couples’ budgets to cut back on discretionary spending while also sharing the essential costs. If we look at the middle-income group, we see a 3.1% decline in non-essential spending for singles compared to a much larger decline of 9.5% for a couple. This extra room in the budgets of higher income households and couples demonstrates the need for flexibility when they come to making retirement income choices.
How taking an income matters
Income drawdown and annuities come with their own benefits and risks that need to be weighed carefully. Sticking to a conservative strategy such as the 4% rule in income drawdown could see your pension pot last but risks not giving you enough income to maintain your standard of living, with only 56% of households able to do so. A more aggressive strategy would see spending targets met in the short term but risk running out of money.
Taking a level annuity from the age of 67 will see an estimated 72.5% meet their initial spending requirements, but over the long-term inflation could erode its purchasing power. Inflation- linked annuities help preserve purchasing power and could see 61% of households achieve their spending. The reality is hybrid strategies incorporating both annuities and drawdown will provide a better solution long term (64%) though these can be complex and include decisions around when to annuitise, and how much money to take from a drawdown portfolio.
Those who can afford financial advice will receive personalised advice to help guide them through these decisions. It also shows the huge role that targeted support can play in helping those who do not take financial advice. Targeted support can not only support people in helping them understand what they want their retirement to look like and how much they need to save, it will also be key, when the time comes, to make those important decisions about income as they progress to and through retirement. It also demonstrates the importance of a coherent policy on savings that enables people to take a holistic view of what they have and how it can be used to maintain their quality of life after work.”
Notes to Editors
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