Making Cents: What to do when retirement is 10-15 years away (Part 2)

AS promised last week, I’m following up with those three other areas I believe are important when planning for your future retirement.

Maximise your contributions
Circumstances and finances allowing, ideally you should increase your personal contributions up to or close to the maximum allowed.

The amount you can contribute is with reference to your age and the older you become the higher the % of your salary you can contribute, so it’s trying to take full advantage of these higher limits.
For example, if you are between 40-49, you can contribute 25% of your salary (and for tax relief purposes there is a cap on salary of €115,000) and between 50-54 it's 30%, between 55-59 its 35% and 60 or over its 40%.

So, you can really take advantage of these higher amounts and put more into your fund than you previously could, and this is especially important if you have to play catch up where perhaps you had previously been under-funding your pension.

Become debt free
I once heard someone say that carrying a mortgage or any other debt into or close to retirement can wreak financial chaos and they’re not wrong.

So, getting out of debt before retirement is not an option, it’s nearly a must requirement.

The ideal way to enter retirement therefore is with a paid off mortgage.

If you’re in your 40’s or early 50’s you have time to make this happen whereby being mortgage free coincides with entering retirement. If you’re in your mid 50’s, whilst it’s still doable it’s a little harder.
Ideally you want to be ratcheting up your pension contributions coming closer to retirement and that’s easier to do when you have no mortgage or debt repayments of any kind.

So, I’d say consider accelerating your mortgage payments so it will be paid off ideally five years before you retire. Find out what needs to be done to make that happen i.e. how much will it cost you in terms of making monthly overpayments or annual lump sum payments.

Review existing pension structure
As you get older, you should gradually adjust the structure of your pension fund, so you begin to take on less risk and protect what you have.

When you were in your 30’s or 40’s it was okay to take on more investment risk because you had time on your side to make up for those years when returns were flat or negative. But once you get closer to retirement age your tolerance to risk should change focus where it’s less on growth i.e. typically equities and more on protection i.e. balanced and fixed income assets, government, and corporate bonds.

The good news is that most group occupational schemes and pension companies managing private pensions offer default type funds that adjust your investment as you get older, so they do the de-risking for you.

And your retirement could and hopefully will last more than three decades, which is why you must continue to invest in equities. And this claim is made with reference to an academic paper known as the Trinity Study, which came out of the Trinity University in 1998.

The study found that if you retire at 65 and put 100% of your fund into cash and bonds, which are very low risk and safe investments, and you withdraw 4% from it every year you only have a 19% chance of outliving it if you live to 95.

I don’t know about you, but I don’t like those odds. I want to live as long as I can without fear of ever running out of money, so how do you increase your odds where you’re guaranteed not to outlive your fund?

And the answer is how you structure your fund.

Assuming you take 4% of the fund each year, you must invest in equities. You can’t ignore them, you just can’t. The factual evidence is overwhelming and anyone who tells you differently doesn’t know what they’re talking about.

If you have at least 25% of equities in your pension fund in retirement and withdraw no more than 4% of your portfolio each year, you have a 96% chance the fund will last 25 years. The % increases when your portfolio has a bigger equity content.

And I understand that it can be tempting to move away from equities altogether to reduce your risk but the growth they provide is very important no matter what age you are, and they must form part of your money invested in retirement. So I’d say get some advice, and that advice should be to maintain a good mix of equities, bonds, cash, property, commodities, and other asset classes that fit your risk tolerance.

Summary
I’ve said this before and I’ll say it again that being proactive and knowing what your finances will look like when you’re retired is the only thing that will bring you peace of mind, now and in the future.
And you can choose to do two things when it comes to planning for your financial future and they are (a) doing nothing and refusing to think about it until you are close to retirement or (b) you can decide to be proactive and figure out what it will look like based on your current savings and contributions.
And I completely understand that we can get busy trying to survive the present i.e. making mortgage payments, putting kids through college and school, to worry about the future and what that will look like. But we still must put some time into trying to figure out what our finances will look like based on what we’re currently doing and the reason we’re doing this, is to discover can or should we be doing things differently that could improve our situation when we’re older and that something different could be as I said already, changing how our pension fund is structured, saving more, paying off debt etc.
But we have to face reality at some stage and there’s no good or bad time to do that. And if you discover that you can’t save more and/or if incredible investment returns aren’t realistic then working past your ideal retirement age or living on less could be your only options but knowing what that future outcome might become is important.

And usually, there are no miracle solutions to create your ideal retirement, not the government, not the stock market, no windfall wins or inheritances, just plain ole saving as much as you can as early as you can. There’s no secret, it’s as simple as that and just knowing what your future income is going to be like based on what you’re doing right now could be the spur you need to take action to do something to improve your future finances or it could give you the reassurance knowing that you’re on track and doing the right things and not doing anything you shouldn’t be to jeopardise it.

Liam Croke is MD of Harmonics Financial Ltd, based in Plassey. He can be contacted at liam@harmonics.ie or www.harmonics.ie