Mind your assumptions when planning for retirement

One of the most difficult aspects of planning for retirement is the fact that it entails making certain assumptions. Assumptions, which are essentially ‘best guesses’, are often based on what has happened in the past, what present conditions are like, and what we anticipate for the future.

When it comes to planning for your future financial stability, several assumptions come into play. These include how much monthly income you’ll need in retirement; how markets will perform over the period of your retirement and thus what investment returns you’ll receive; what interest rates will do; and how inflation will act. These, in turn, are dependent on a myriad of forces including local politics and global economics.

The problem with assumptions is that they are often accepted as certain to happen, without proof. When a financial adviser presents a plan based on a certain percentage of annual growth on your investments, this is an assumption, not a guarantee.  However, many of us simply presume the plan will unfold as it stands. 

But what if market factors don’t play ball? 

If your plan calls for an average investment return of 8% per annum to give you a certain level of monthly income, what happens if markets only return 7% or even 6%?  How will that affect your income? And what if inflation doesn’t stay within the Reserve Bank’s target band of 3-6% and increases to 9% as it did at one point in 2023?  Your purchasing power could be affected and you’re likely to exceed your budget.

Health and wellness is probably the second most important aspect of retirement planning, and another instance where assumptions are made.  It’s easy as a healthy 50 or 60 year old to assume that you’ll continue to be healthy and that, therefore, your future medical expenses will be pretty much what they are today plus inflation.  Unfortunately, in most cases this isn’t what occurs. As we age, so we become increasingly vulnerable to various illnesses and impairments.  In addition, medical inflation can be much higher than consumer price inflation (CPI).

One way to reduce the guesswork in retirement planning is to diversify your retirement income and consider a life annuity, which will pay you a guaranteed income for life. While life annuities have a reputation for being inflexible, there are options to retain some flexibility and safeguard your income.

An example of this is a blended annuity, which combines the benefits of a living annuity with the certainty of a life annuity in one investment vehicle.  You decide how much of your investment is allocated to the living annuity and how much is allocated to the lifetime income portfolio, which will pay out into the living annuity for the rest of your life, providing a safety net by making sure you never running out of money.  

While assumptions are a necessary part of retirement planning, do pay attention to them and consider whether they are, in fact, ‘best guesses’ and how your circumstances might evolve over time. Speak to your financial adviser and ‘stress test’ your plan by looking at a range of two or three different assumptions, as this will enable you to plan more effectively.