What it means
For most people the challenge is that retirement has no pay cheque. Income has to come from state or employer pensions, personal savings, investments and sometimes part-time work.
The sums involved are large because retirement can last twenty or thirty years. Two risks shape every plan.
Longevity risk is the chance of living longer than your money lasts, and inflation risk is the chance that rising prices eat away the buying power of fixed income. Investment returns also matter, because a market fall just before or after retirement can cause lasting damage.
Retirement planning has two phases. The accumulation phase is the working years, when you build up savings through contributions and investment growth.
The decumulation phase is retirement itself, when you draw the money down in a controlled way so that it lasts. A common rule of thumb is to estimate how much annual income you will need, subtract guaranteed income such as a pension, and then work out the savings required to fund the gap.
Another rule of thumb says that withdrawing about 4% of the starting pot each year, adjusted for inflation, has historically been a reasonable starting point, but it is a guide and not a guarantee. Individual circumstances such as health, housing costs and family support can change the answer completely.
For business owners and managers, retirement also has an organisational side. Employers offer pension plans, succession plans and phased exits, and these affect hiring, costs and knowledge transfer.
Finance teams therefore track pension obligations carefully because they can be a major liability on the balance sheet. The timing of when you stop matters more than most people expect.
Retiring a few years earlier means fewer years of contributions, more years of spending and a longer period when the money must last, so small changes in the retirement date can alter the numbers a great deal.
In practice
Real-world examples.
Example
A marketing director aged 55 uses an online calculator to see whether she can retire at 62. She finds that her current savings and contributions would give her only 70% of the income she wants, so she decides to raise her monthly contributions.
Example
A self-employed electrician has no employer pension. He sets up a personal retirement account, pays in a fixed percentage of each job and plans to sell his van and tools to a younger colleague when he stops.
Example
A couple in their sixties meets an adviser to decide whether to draw on their savings first or delay claiming state benefits. The adviser models both options and shows that waiting increases their guaranteed income for life.
Formula
Calculation
Savings needed = (Annual spending - Guaranteed income) / Withdrawal rate
Suppose a person expects to spend $60,000 a year in retirement and will receive $20,000 a year from a pension and government benefits. The income gap is $60,000 - $20,000 = $40,000. Using a 4% withdrawal rate as a rule of thumb, the savings required are $40,000 / 0.04 = $1,000,000.Case study
Seen in the real world.
Calloway and Reed is an illustrative, fictional accounting practice whose senior partner planned to retire in five years. His plan relied heavily on selling his share of the practice, but he had saved little outside it.
The practice's finance manager modelled his income in retirement and showed that the share sale alone would cover about eight years of spending. She proposed a phased exit, with part-time work for two years, higher pension contributions in the meantime and an agreement to hand over his clients gradually.
In this fictional case the revised plan stretched his money to cover his expected lifetime and protected the practice's client base. The illustrative lesson is that retirement is a cash flow problem which needs a plan built years ahead. The partner later said the most useful step was simply writing down what he expected to spend each month, because the figure was higher than he had guessed.
Watch out
Common mistakes.
- Starting to save too late and assuming a few years of large contributions will make up the difference.
- Underestimating how long retirement will last and running out of money in later life.
- Ignoring inflation and healthcare costs when estimating the income needed.
Questions
People also ask.
How much do I need to retire?
It depends on your spending, your guaranteed income and how long you expect to live, and a common starting point is to divide the income gap by a sustainable withdrawal rate.
What is the difference between accumulation and decumulation?
Accumulation is saving and investing while you work, and decumulation is spending those savings in a planned way once you stop.
Should I invest differently as I get closer to retirement?
Many people reduce the share of volatile assets as retirement approaches, but the right mix depends on your income needs, other resources and tolerance for risk.
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