Don’t let ‘Bank of Mum and Dad’ ruin retirement
As parents are warned their generosity is putting their own old age in peril...
IT’S the nagging fear for any parent helping a grown-up child to get on the housing ladder, buy a car or pay for a wedding: can you afford to sacrifice thousands of pounds from your life savings without ruining your own retirement plans? Last week, a report by Legal & General sounded the alarm on over-generous parents gifting lumps of their retirement savings away – with the serious risk of damaging their own financial security.
As many as a fifth of over-55s have raided their pension pots or savings to help the next generation on to the housing ladder – and L&G said the Bank of Mum and Dad handed out £6.3billion to first-time homebuyers last year.
It’s not surprising that many of us feel like we want to help our children get a head start in life if we can. After all, Millennials – children born between 1980 and the mid-1990s – are widely accepted to be the first generation financially worse off than their parents.
Yet at the same time, we all seem to be living longer and longer, and are constantly being told we need to save more for retirement. In fact, the chances of living a long retirement are at an all-time high; one in ten over-55s is now likely to reach the age of 98 and plenty are on track to hit 100.
So is it really possible for middle-class parents both to help their offspring financially AND stay on course for a comfortable retirement? The answer is ‘yes’ but you will need to do some number-crunching and plan your next steps extremely carefully.
HOW MUCH DO I NEED TO SET ASIDE?
THIS is the key question to answer before you give anything away. Once you know that magic number, you can help your children financially without fear. Your first step is figuring out your ideal retirement income. What could you live on comfortably when you stop work? Remember, you are likely to have paid off your mortgage and the children are likely to have flown the nest.
As a good rule of thumb, pension giant Scottish Widows says most people it asks give a figure of around £25,000 a year. That might sound like a lot, but let’s break down where it could come from.
For most people, the State pension will provide a decent chunk of the total. At current rates, you receive £8,767 a year, guaranteed for life and rising with inflation.
The current qualifying age is 65 for men and women but it’s rising to 66 and then 67 in the coming years and is expected to go higher still. Take that away from your £25,000 target and you’re immediately down to £16,233. If your spouse also qualifies for the full amount, you could subtract another State pension income and take the total extra income required to £7,466.
Next, factor in any guaranteed pension you have built up at work. It’s very easy to lose track of these pensions as you move jobs, so hunt down old paperwork or contact your old HR department. Also try The Pension Tracing Service at gov. uk/find-pension-contact-details.
Many approaching retirement will find they have built up entitlement to what is called a final salary or ‘defined benefit’ pension. This is a guaranteed income which typically rises in line with inflation.
These types of pensions are extremely valuable and are still prevalent in the public sector. However, they have been steadily phased out by private sector companies. For example, a lifelong teacher or nurse might expect in excess of £10,000 a year in retirement.
If you were only a member of a private sector scheme for a short time, you may be due a few thousand pounds. Either way, you should now have an idea of how close you are to your target income. If you are nearly there you could take the plunge and make that gift to the next generation. However, many people will find they are still short. Let’s say you are £10,000 a year out. That’s where other savings pots come in. Most modern company and private pensions are ‘defined contribution’ schemes. This simply means your savings are going into a pot and the money is then invested in the stock market.
When you reach 55 you can start making withdrawals. To work out how much you need in this pot, you should first establish a rough estimate for the number of years you will be making withdrawals.
None of us knows how long we will live. But the Office of National Statistics website provides a useful starting point.
Go to ons.gov.uk and type in ‘What is my life expectancy?’ in the search bar at the top of the page. Click on the first link and you will be able to tap in your current age to reveal your likely lifespan, based on UK averages.
It’s very crude – for example, I did this and apparently I should make it to age 88, but have a one in ten chance of hitting a century – but at least you now have a figure to work with. So let’s say, based on averages, you’re on track to be retired from age 65 to 88. That’s 23 years of income to fund. In our example – where you are £10,000 a year short – that means having at least £230,000 in your pension pot by the time you retire.
If you eat into this sum for gifts to children you will be reducing your retirement income below the magic £25,000 mark.
WHAT CAN I DO TO FREE UP CASH?
IT’S worth bearing in mind that retirement experts say many pensioners happily live on a lower income as they age. This makes sense when you think about it: in your 60s you might go on they type of holidays that you would no longer fancy or manage in your 80s.
If you worked out that you could live on £15,000 after the age of 85 instead of £25,000 in our example, you could free up £30,000 (three years earning £10,000 less income) to give as a house deposit for your child. Many people leave a portion of their money invested in the stock
market during their retirement through so-called income drawdown plans. The benefit of doing this is that your pot has a chance to grow as you make steady withdrawals. As a result, you may not need to set aside as much to generate a £10,000 income that lasts for 23 years.
However, it’s a risky strategy – you could end up worse off – so it may pay to ask a professional adviser to devise a safe plan for you. Some advisers, for example, will put your money into shares that pay high dividends. You may be able to live off this regular income alone – called the ‘natural yield’ – meaning you can leave all your capital untouched.
If you’d rather leave an inheritance to children than help them financially now, this approach could suit you. Nathan Long, senior analyst at Hargreaves Lansdown, explains: ‘At the moment we could set up a portfolio of shares and bonds to generate an income of about 4 per cent. A pot worth £250,000 produces an income of £10,000.’
If you really want to guarantee a £10,000 income for life, you can buy a so-called annuity. This is an insurance product where you hand over a lump sum in exchange for a set amount every month.
The bad news is that annuities – particularly ones that rise in line with inflation to maintain your spending power – are expensive because insurers calculate monthly payouts based on interest rates, which are low at the moment.
For example, if you have been especially prudent and saved £1million – about the maximum permitted if you don’t want to pay tax penalties – you have certainly done well. But this does not mean you will live the life of a millionaire in retirement, says Robert Cochran, pension specialist at Scottish Widows.
He says: ‘Let’s assume you take the permitted 25 per cent tax-free lump sum from your pot – in this case £250,000, which you put aside for emergency costs, possibly as well as a gift – and convert the rest into an annuity. If you want the income to rise with inflation each year it will start at £976 a month.’
Jon Greer, head of retirement policy at wealth manager Quilter, says: ‘Some people could spend 40 years in retirement. Over the last 40 years, for example, inflation meant that goods costing £100 in 1978 were priced at £564 in 2018. So it’s worth thinking about how you will inflation-proof your retirement income.’ THE truth is working all this out for your own personal circumstances is extremely complicated. That’s where a financial adviser can come in useful. Many have access to so-called cashflow tools that are a huge help working out how much you can afford to give away. These are computer programmes that can forecast how much big outlays at the start of retirement may impact later on.
You can find free (simple) cashflow calculators from investment websites such as fisherinvestments.com. Wealth managers 7IM have a free app called ‘7Imagine’. RetireEasy has paid for cashflow modelling software for individuals starting at £2.99 a month.
For the full effect, though, you may need to visit an adviser. To find one near you, use the Unbiased.co.uk search tool. Sandra Paul works for Prestwood Group, which supplies financial planners with a popular modelling package called Truth. Using the software, a planner taps in all your details from income, savings, property and spending such as on cars and your children’s education.
At a press of a button, the system highlights how working a few years longer than first planned could help your money last much longer.
Paul says: ‘Let’s say you originally planned to retire at the age of 60 but decide to carry on until 66. Not only do you have six more years of salary and six more years of pension contributions but the pension also has six more years to grow.’
Another option for making up the shortfall created by dipping into your pot is to switch to investments that are riskier but likely to produce a higher return. Greer, from wealth manager Quilter, adds: ‘Cashflow modelling plans can project the impact of inflation and the expected returns on assets. It will highlight that where you have cash savings paying less than inflation they will deplete in value over time.’