How to make your pension last until you reach 100

People must save more money, work longer or generate a higher return on their investments to make their wealth last the course

While most of us welcome our steadily rising life expectancy, there is also a danger that it could blow up in our faces.

As growing numbers will live to the ripe old age of 100 or beyond, those extra years will have to be paid for.

Nobody wants to spend their final years worrying about every penny or cent, fearing their retirement funds will run out altogether.

Last year, the World Economic Forum warned of a ticking time bomb as the world gets older. There are now more people over the age of 65 than there are under five for the first time in human history – but we aren’t saving for it.

In just eight countries – Australia, Canada, China, India, Japan, Netherlands, UK and the US – the retirement savings gap is projected to balloon to $400 trillion by 2050, it warned.

If you want your pension income to last as long as you do, you need to work at it, and the task is getting harder. Your money might have to stretch for 25 or 30 years, and possibly longer.

The first step to defusing the time bomb is to build a big enough pension pot to fund a comfortable retirement. The sooner you start, the better. That means saving as much as you can, as early as you can. Not easy, as the Covid-19 pandemic hits the global economy.

As retirement looms, you then have to work out how to make your savings last the course.

Andrew J. Scott, professor of economics at London Business School, who recently held a Nasdaq Dubai webinar entitled Implications of a 100 Year Life for the Financial Sector, says rising life expectancy poses a new challenge for investors.

The technical name for it is “longevity risk”. Put simply, this means you could outlive your money.

You have three ways of making your wealth last the course, Mr Scott says. “You either save more money, work longer or generate a higher return on your investments.”

Saving more money is sensible but not always easy, while it is hard to get a higher return without increasing risk, Mr Scott says.

More will therefore work into their 60s and 70s, which has a triple benefit. “It builds up your wealth, keeps you engaged and allows you to invest in higher-risk assets such as shares for longer.”

However, to do this you also have to maintain your workplace skills and stay healthy, which cannot be guaranteed.

At retirement, the classic way of hedging against longevity risk is to buy an annuity that pays a guaranteed income for life, no matter how long you live. That has changed, too.

Most people now find these too restrictive, especially as returns have crashed since the 2008 financial crisis, along with interest rates.

Today, each $100,000 in your pension pot would secure a level annuity income of less than $5,000 a year. If you wanted that to rise in line with prices, your starting income would fall to below $3,500.

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Shares will fuel the growth you need to replace your 4 per cent withdrawal, while bonds offer downside protection against a stock market crash

You could still buy an annuity with some of your money, treating it as an insurance product rather than an investment, Mr Scott says. “In the US, there is growing interest in deferred income annuities, which you buy in your 60s but do not start paying income until you turn, say, 85.”

Steve Cronin, a financial independence coach and founder of DeadSimpleSaving.com, says most expats no longer rely on a single company pension, but have a pool of investments, including investment fund portfolios and maybe property, too. "This gives them more freedom around how to take money out of their portfolio."

Mr Cronin suggests abiding by something called the “4 per cent rule” at retirement. This states that if you withdraw 4 per cent of your portfolio as income each year and leave the remainder to grow, your pot will never run dry.

This is known as the safe withdrawal rate. “It means you won’t draw too much and run out of money in your 80s, but won’t end up with a pile of unspent money you could have enjoyed.”

Mr Cronin says you can also use the rule to calculate how much you need to save to generate the income you need at retirement.

Put simply, if you reckon you can live on $40,000 a year, then you will need a million-dollar portfolio to achieve it.

The 4 per cent rule isn’t infallible, your pot could deplete faster if we endure a long period of stock market underperformance, but it is a handy rough guide.

A hopeless retirement concept jar with coins and dried plant

Mr Cronin suggests that at retirement, your portfolio should be 60 per cent in a global stock market funds, and 40 per cent in a global government bond funds. “Shares will fuel the growth you need to replace your 4 per cent withdrawal, while bonds offer downside protection against a stock market crash.”

A popular and easy way of doing this is to buy a low-cost exchange traded fund investing in global equities, such as the Vanguard FTSE All-World UCITS ETF. Then combine this with the iShares Global Govt Bond UCITS ETF, which invests in government bonds from Canada, France, Germany, Italy, Japan, UK and the US.

Stuart Ritchie, director of wealth advice at AES International, says you should look to generate enough income from your retirement portfolio to cover at least 70 per cent of your current spending.

If you are falling short, beware of taking on too much risk in a desperate bid to catch up, especially on the advice of a pushy salesperson. “Avoid anybody talking of ‘investment guarantees’ or even ‘capital protection’, which nobody can honestly promise.”

Mr Ritchie says one rash or misguided move in the years before retirement can destroy your portfolio, with no time to recover.

Another mistake is to leave too much money in cash, particularly if anticipate a lengthy retirement. “If you do that, inflation will steadily erode the value of your money in real terms.”

Mr Ritchie recommends building a globally diversified portfolio of low-cost ETFs that match your attitude to risk. “This is the best guarantee any investor can have.”

Stuart McCulloch, market head of The Fry Group Middle East, suggests sitting down with your partner to work out what you are likely to be spending in retirement.

Then look at how much you are likely to have saved, and what you can do to increase your combined pot.

How far your money stretches will depend on living costs and the tax regime where you retire. “Remember that most people spend more in the early years of retirement, when they are more active, and less after age 75,” Mr McCulloch says.

He suggests taking specialist financial advice. “A good financial planner will use cash-flow modelling software to plot out your current wealth and future needs, to see how much income is sustainable and avoid exhausting your pot. This takes the guesswork out of it.”

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Most people spend more in the early years of retirement, when they are more active, and less after age 75

Your personal attitude to risk is also an issue. Some are happy to remain invested in shares in retirement, despite the added risk, while others will favour lower return assets such as cash and bonds.

The bigger your portfolio, the more risk you can afford to take.

The challenge of making your money last in retirement will only get harder as life expectancy continues to rise.

Mr Scott says by the time you retire, your money might have to last for even longer than today. “People over 100 is now the fastest-growing global demographic. You should prepare for living an unusually long time.”

The clock is ticking. No time to waste.

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