Welcome back to the #1 Investment and Retirement Planning Blog & Podcast in Ireland. Of late our focus has been very much around preparing our finances in advance of, and indeed after we leave full-time employment. Some people call it retirement, other people don't like that term (hear Fin's interview here!).
This week, as promised we will explore that big question for many, When can I retire? A few readers got in touch after Blog 118, where we looked at maximising the income you achieve from an ARF. They were asking why not just retire earlier? So here we go!
Oh, for those of you that don't like the term 'retirement' I'm delighted to share an alternative! I came work by a US guy, Don Ezra recently. All about preparing for retirement. He calls retirement phase 'Life Two'. He suggests it came about when the accronym for 'Life After Full Time Work' (LAFTWO) was converted into 'Life Two'. I like it! I also like 'Accumulation' phase and 'Spending' phase however if you are anything like many who find their calling in Life Two you may find yourself so busy that you don't have much time for spending!
So, how early can we head from 'Life 1' into 'Life2'?
Much like all aspects of retirement planning there are multiple aspects to this question, and little in the way of definitive answers! In my experience, the key questions that need to be considered here are the following:
- How early CAN I retire from my employment/pension scheme?
- How early do I WANT to retire?
- How much INCOME will I need in retirement to sustain my lifestyle and commitments at that age?
- How much do I need in my retirement POT to retire early?
In fairness each of these 4 questions are significant and worthy of a separate Blog each. They are on the list and I look forward to getting to share some thoughts on these soon. I would also suggest that if you have any of these 3 questions in your mind of late that they are hugely worth investing time and thought to figure out what your own personal answers might be.
Today, as always, I will encourage you to begin with the end in mind, taking on the 4th question, with reference back to Blog 118 (Podcast 145). Please do bear in mind that each of us will likely have a different answer to this question, but the following will hopefully give some insight that you might consider using.
How Much Do I Need In My Pension Pot To Retire Early?
Purely as a recap, in our example in Blog 118 we had €1m pension pot, we were 65 at retirement and we were drawing 4% per year. We also simulated our long term success rates in drawing an income which increased every year in line with inflation, and then another where we only took increases in years where our portfolio had positive returns (Guyton Withdrawals). The former had a 65% success rate of getting us to 95 and the latter 95% success rate. Oh, and this was all while investing in a 90/10 well diversified and blended Equity and Bond portfolio.
All of this was based on aiming to draw the 4%, increasing to 5% from age 71 onwards (as per Revenue rules). The aim was to deliver this income for 30 years, or until 95 in our example. So if your future plan is to retire at 65, and have a predefined pension pot based on the traditional 4% rule, is there scope to explore retiring earlier, say at 60, or heaven forbid even 55?
I will place the caveat that you may not WANT to retire at this age, or indeed you may not be ABLE to access your funds as early as this. What we are focusing on here is whether or not it is feasible from a financial perspective based on empirical data. Plus, if you are aiming for Financial Independence (FIRE) and want to know your 'number' then this will be a very useful piece of research.
Financially, How Can I Retire At 60?
Again, we are assuming the above scenario applies. You need €40,000 per annum gross from your own pot, raising to €50,000 from 71. You are married and between you and your partner will receive 2 State Pensions from 65, which will equate to €25,000 in total.
In essence, in this example you are going to rely on pension tax free lump sum and the €40,000 per year to sustain your lifestyle from age 60 to 65 before the State Pension kicks-in, and your income rises to €65,000! From age 71 your Gross Income rises to €75,000. These are obviously Gross Income figures, you will be needing to Income Tax and USC on Gross Incomes over €36,000.
So will this strategy work from age 60 to age 95? If your income is increasing each year in line with inflation then the chance of success are not great. Based on historical data there has been a 64% probability of success.
Interestingly the worst case scenario was that your pot expired at 79 years of age, 19 years into your planned 35 years. You will see from the graph below that this was on the back of extreme inflation rates, as opposed to negative investment returns - although there was some correlation. The red line in this graph below represents the worst-case-scenario, and you see the income drawn from the portfolio spikes during the high periods of interest rates. The impact of drawing this income every month at hugely inflated rates, is that the portfolio expires dramatically.
Having said that, in 65 of 100 scenarios this strategy HAS worked out over a 35 year period for the investor. If you are hoping to retire at 60, draw the above %s of your pot for the next 35 years then you have a reasonable chance of success adopting this strategy.
Interestingly, if you had the option of taking only the 4% for the full 35 years, instead of having to take 5% from 71, the approach had a 82% probability of success. It is still not an iron-clad result but significantly higher probability (26%) than the 4% rising to 5% approach.
What some might find really surprising is that the very worst annual income that was possible under this strategy was €37,000, or 3.7%. The very best? €105,000 per year, or 10.5%! Every other scenario supported between 3.7% per year and 10.5% per year, for the full 35 years!
How Long Will We Live??
This is a pivotal factor to consider here. I know that in our scenario we are purely shooting for 95 years of age, so the portfolio needing to generate income for 35 years. However what are the chances of us living that long!? Well statistically speaking there is a 48% chance of either you or your partner being around at 95 years of age, if 60 today! So you could argue that a retirement income strategy with a 65% probability of lasting to 95 actually stands a very healthy probability of outliving both of you - so in real terms it could be argued that it's a very solid strategy overall.
Financially, How Can I Retire At 55?
Now we're really stretching things in this scenario, if we consider that we are planning for a 'Life 2' of 40 years! 4 decades! We'd surely want to have some form of activity or deep interests to keep up motivated for that. I refer back to our interview with Derek Bell of RPC in which we discussed some of the main challenges, and opportunities, for people when considering a multi-decade retirement.
Again, we are aiming to take 4% from age 55 to 70, and then 5% from 71 to 95. Probability of success, taking increases in line with inflation every year stood at only 58%. Worst case scenario you ran out of money at 75, 20 years into your Life 2, essentially half-way towards your goal. As equally unlikely as it is, the best case scenario was that your pot outlives you and had a final pot value of over €7m (or €25m if not adjusted for inflation!!!).
If you, like many investors, seek to achieve at least a 90% probability of success there is a way, however it requires you having a flexible approach to your income each year. This is a topic we will be exploring in the very near future but just to whet your appetite how about the following! So if were are staring at a 58% probability of success however were willing to be flexible about your income you could relatively easily get that to over 90%. If you took a flexible approach, increasing your income year to year by a max of 3%, even if inflation was more than that. Equally as important, you took a spending cut of up to 3% during periods of deflation. The impact of this spending flexibility was a jump in probability of success from 58% to 93%. Sure there would be some relative pain when price of goods go up sustantially but your income goes up only marginally.
We could keep going. We can aim for 50, 45 etc etc however hopefully the message is clear. If we intend to draw 4%, increasing to 5% from our pots, at least with an equity-focused portfolio, we will need to manage our incomes and our increases very carefully. It is something that needs to be monitored and tracked on an annual basis at least, if we want to have a long term successful outcome. Having said that, if a highly probably success rate is our desire, having a flexible approach to our income is a strategy that can pay dividends (no pun intended!).
If and when you seek assistance in your own retirement income planning please check out the work with Paddy section of our site and see if we might be a good fit. Also, please do get in touch with any ideas, suggestions or questions on this piece today, would love to hear from you.