This article is part of Morningstar's Guide to Retirement Saving. All this week we are arming you with the tools you need to boost your pension pot and secure the best possible income in retirement.
Christine Benz: Let's say someone is getting close to retirement--maybe within five years or so of their anticipated retirement date--and they're walking through all of the things that they want to have lined up beforehand. What should be on their checklists?
Christine Fahlund: First of all, have you saved enough money? The way to address that is to see a financial planner, who can provide their wisdom and perspective on the topic. There are also web tools out there.
I would advise that when you rely on any web-based tool, just be sure that it's using Monte Carlo analysis and not some assumed rate of return like 7% or 6%. We strongly encourage people to recognise that everything is uncertain. The future for all of us is uncertain, and market conditions, in particular, are uncertain.
Benz: So Monte Carlo randomises outcomes?
Fahlund: It does, and over a long period of time. Today, retirements are often at least 30 years. So you need to be modelling for at least a 30-year retirement. Of all those projections of your strategy in all kinds of market conditions, what percent of the time did the strategy run out of money before the end of your retirement? So if it were 20% of the time, that means that strategy would be successful 80% of the time and you would not have run out of money.
Benz: What's an acceptable probability of success, in your view?
Fahlund: About 80% to 90%. We worry about over 90% just because it starts to suggest a guarantee or promise of some kind. You know, when you say, "Oh, this one gave me a 97% likelihood of not running out of money." Well, that sum was too promising.
If you are acknowledging that between 10% and 20% of the time, if you use this strategy you might run out in advance, now you are in a good place because you are not leaving too much money on the table. You want to use that to enjoy retirement.
Benz: One of the things you commonly hear from people who know that they have not saved enough for retirement is that they are just going to continue working as long as they can. You have done a lot of work looking at just how valuable that can be if you can delay that retirement date. Let's walk through those benefits.
Fahlund: The first benefit is so obvious that a lot of people miss it, and that it's those additional years of salary. The key there is to maintain the income and maintain the benefits for as long as you can, but not give up the play.
If you are in your sixties, it's your time. It's your time to start taking the cruises, visiting your grandchildren for longer, or start with some serious photography. Whatever it is, you shouldn't think that you have to wait for a gold watch at the end of your sixties in order to finally get permission to play.
Benz: Another thing you've written about is how additional retirement plan contributions when you are, say, in your early sixties tend not to be all that impactful.
Fahlund: That's right. If you think about saving in those first few years, you don't get much compounding initially, and then that starts to rise dramatically. But if you are in your sixties already and you add a contribution and then let's say you retire at 68, that money has not had much time to compound. So, maybe some of that money, anything you don't need to get a match, you use to help pay for the cruise.
Benz: I often talk to people, and they say, "My plan is just to work as long as I possibly can."
That's advantageous for the reasons you've outlined. But what are the risks with that plan if you haven't accumulated enough to retire earlier?
Fahlund: You could end up having nowhere near enough money to retire, and all of a sudden you can't find a job. One of the things that happens for retirees is they either have their mind set on moving to the coast or to live near the grandchildren, or they plan to stay in their home and their hometown forever.
And once you commit to a specific geographic location, you don't necessarily have the luxury of replacing the job that you had when you were still working. If you move, it could be that the type of career you had isn't even available. So you need to be very careful about how you think about working. And you need to have saved as much as possible before you retire.
A plan B that would be more practical would be equity release. That's something that is available for people who've paid off the mortgages on their homes. It's a much more predictable plan B than continuing to work.
Benz: Anything else that I should be checking before I think about retiring within the next five years or so?
Fahlund: If you do have a pension, what are the options, and, in particular, what are the options if you are a couple? What will happen if one of you passes away?
Many annuity products will give you a guaranteed income stream. Are they part of the equation yet, or are you going to think about that? If you are married, or have a partner, you must decide how all the decisions you make are going to affect whichever one of you survives.
A version of this article was originally published on Morningstar.com
