It should come as no surprise to hear that a person’s wealth is likely to peak at retirement age. You start off adult life with few assets because you have limited income which is easily spent on property costs, daily living and perhaps supporting a family.
As you develop in your career and expenses become more manageable, you should begin saving in earnest and, assuming the investments perform, your overall wealth will increase.
Once retirement starts, your earnings reduce or stop, although you probably have reduced committed expenditure going out. You may also take the opportunity to travel or do other things which you did not have the time or money for earlier in life. This will probably give rise to a slow decline in wealth as you enjoy the fruits of a life of hard work.
Only 30 years ago, retirement lasted around ten years; now the average length of retirement is more than 20 years. That has a huge impact not only on the national economy with rising healthcare and State pension costs, but also on an individual’s needs.
One key challenge that people face once they stop work therefore is how to preserve the wealth that they have accumulated during their working lives, maintain a desired lifestyle and also leave something for unforeseen or uncertain future events. At the other end of the scale, if one is blessed with enough to easily cover everyday and rainy day expenditure, clients ask how much do I need to keep in savings or should I be giving assets away and what about inheritance tax?
When I am talking to such individuals, I suggest that they consider allocating separate “pots” for their assets. Each pot might be held in a different bank account or sometimes a spreadsheet is sufficient; it depends on the person. I find that having a clear demarcation will help focus the mind on what assets are retained for each purpose and where a shortfall might be arising.
The first pot is for everyday living. To determine the size of this pot you should be thinking about what your regular income will be. You are likely to be entitled to pensions, whether that be a state or a private pension and you may also have income from investments or some consultancy positions. You then make a list of all your regular expenditure, including home maintenance, utilities, clothing, food, tax and health insurance.
If your expenses are less than your income then you do not need an immediate pot for living expenses because they will be covered by your ongoing income. However if your expenses are greater than your income, you will need to consider a savings pot to cover the annual shortfall.
The second pot is for health and long-term care. The sad reality of the UK health system is that if you suddenly become seriously ill then you could be well looked after. However, if you are suffering from a long-term chronic condition such as dementia or physical frailty you are likely to need more care than the government can provide. For those who are able, it is a good idea to keep an amount of savings to cover health or care costs whether that be for support at home or in a care home. Hopefully this pot will not get touched but for those who are able, I personally consider it a high priority to keep at least three to five years care costs available in assets which can be called upon on short notice.
The third and final pot is for gifts and rainy day items. This fund will cover one-off expenditure such as special holidays, maintaining your home, or helping your kids or grandchildren with a property deposit. The amount required for this pot is very individual and would on the size of your family and friend group, your lifestyle choices and your age.
If you still have spare assets or other cash available after all of these pots are full, you should start think about giving away assets and reducing inheritance tax because if you keep hold of wealth in your name then you will be pay inheritance tax on assets, which in practice are unlikely to ever be needed by you. Even at this stage, divesting of assets and IHT planning is not for everyone and each situation needs careful consideration.
I do realise that these suggestions are for the more comfortable and privileged who have the option of putting money aside and some people will not manage to fill their everyday living pot. However by looking at your retirement finances with this approach it may help you to prioritise the expenditure and savings in the years ahead.
Geoffrey Hollander is a general practice partner and a specialist in family businesses at Cameron Baum Hollander Chartered Accountants. For further information, email him at geoffrey@cbh.co.uk