Your Retirement Will Cost More Because of Brexit

Nearing retirement? You may want to rethink your pension plans as thanks to Brexit, to fund the same income in retirement you will now have to save 14% more

Emma Wall 14 September, 2016 | 9:51AM
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Think your retirement is safe from the Brexit fall out? Think again. According to calculations by BlackRock, market movements following the EU referendum will mean you will now need to save 13.7% more to fund the same level of retirement income.

Much of the shortfall is due to government bond yields – which have come crashing down since the vote

In June 2015, BlackRock’s Cost of Retirement Index indicated a 55-year-old would have to save £19 for every £1 of annual retirement income. But fast forward to this month, and the same pension saver now needs £28 to fund every £1 of annual retirement income. This is an increase of 42% - and the steepest sweep of the curve comes in the past few months since the referendum result. Since Britain voted for Brexit, the cost of retirement has increased 13.7%.

“Looking at the broader market, you would probably feel good about your pension potential right now,” said Tony Stenning, head of Retirement for BlackRock. “The stock market is up since the Brexit vote, and inflation remains incredibly low. But investors must think long term – inflation will rise, and your savings have to cover a multi-decade retirement.”

Much of the shortfall is due to government bond yields – which have come crashing down since the vote. Annuity prices are based on the 15-year gilt yield, which now sits at just 1.23%, but has been as low as 0.98% last month following the Bank of England Monetary Policy Committee’s decision to cut interest rates to 0.25%. June 2015, you could get a yield of nearly 2.5% on a 15-year gilt, showing how considerably the income potential for retirees has fallen in such a short space of time. Look at little further back to early 2014 and a 15-year gilt yielded 3.42%.

While you no longer have to buy an annuity at retirement, thanks to pension freedoms introduced in April 2015, they remain the only guaranteed product on the market – and if they were to revert to more historically normal rates an attractive option for pensioners. Annuities are versatile, and can be used as part of a portfolio approach to retirement provision; annuitise your essential expenditure and use income paying investments or drawdown to fund the rest.

Drawdown is Dangerous in a Low Return World

Research by Bengen in 1994, suggests an initial safe withdrawal rate from a retirement portfolio is 4% of savings - inflation proofed and assumed to last for 30 years. This finding led to the creation of the “4% Rule,” a concept that is often incorrectly applied: The “4%” value only applies to the first year of retirement, whereby subsequent withdrawals are assumed to be based on that original amount, increased by inflation.

But Morningstar research has debunked the 4% rule. Findings suggest that financial advisers and retirees in the United Kingdom should use lower initial safe withdrawal rates than noted in prior research—the lower end of the range now starts towards 2.5% or 3% and not the previous 4%. The generous capital market returns of the prior century that bolstered a comfortable and long-lasting retirement portfolio may give 21st-century retirees a false sense of security.

And Stenning agrees that the 4% rule may no longer be safe.

“We are all living longer – our chief executive Larry Fink called longevity the defining challenge of our ages. While the cost of retirement gets less as you get older, the risk of running out of money is greater.”

Adam Ryan, head of EMEA Diversified Strategies for BlackRock adds that finding assets which can return 4% in the current market environment is increasingly difficult.

“Equities are still above the 4% return target – but only just for developed market stocks,” he said. “Real estate and infrastructure should deliver, and less liquid assets such as private equity. But that comes with risk.”

The information contained within is for educational and informational purposes ONLY. It is not intended nor should it be considered an invitation or inducement to buy or sell a security or securities noted within nor should it be viewed as a communication intended to persuade or incite you to buy or sell security or securities noted within. Any commentary provided is the opinion of the author and should not be considered a personalised recommendation. The information contained within should not be a person's sole basis for making an investment decision. Please contact your financial professional before making an investment decision.

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About Author

Emma Wall  is former Senior International Editor for Morningstar