Pensions  

Cash flow modelling with rising living costs in retirement

This article is part of
Guide to rising living costs

Cash flow modelling with rising living costs in retirement
Credit: Hollie Adams/Bloomberg

While the rising cost of living affects both working and retired clients, the potentially finite nature of decumulation means that rising costs can be of greater concern to retired clients.

“People who are retired haven’t got the luxury of turning on the taps of salary,” says Rosie Hooper, chartered financial planner at Quilter Private Client Advisers.

“When you get to retirement you start to think, ‘This is it, this is my whole wealth, this is all I’ve accumulated’.

“And then all of a sudden, inflation and rising living costs feel really scary, because it’s not like you can work an extra shift or decide to get a promotion.”

Different sources of retirement income

As well as distinguishing between working and retired clients, further differences can be drawn among retirees.

“For those who are on a low income and perhaps that income is secure – so perhaps they’re mostly dependent on a state pension, or they have a defined benefit pension – and they don’t have a lot of wiggle room, they will be much more sensitive to increases in the cost of living,” says Jamie Smith, partner at Foster Denovo.

Inflation-linked increases in state and DB pensions can somewhat provide a cushion against rising living costs.

But Claire Trott, director of Technical Connection, highlights how the timing of increases is delayed from the point when they are calculated, with September’s CPI figure usually determining an increase that takes place in April.

And a final salary scheme will usually increase up to a maximum of 2.5 per cent, says Louise Higham, financial planning director at Tilney.

“If you’ve got any inflationary increases above that figure, you may find that your net income is affected by the rising costs of living.”

Meanwhile, clients who are taking money from an income drawdown may have to increase the amount they are taking, which could affect the longevity of the fund, warns Higham.

“If they’re taking out 10 per cent a year but are in a low-risk portfolio that might only produce 3 per cent a year net return, then they’re using quite a lot of the capital.”

For clients without fixed income sources and who maybe rely on cashing in any liquid investments, William Stevens, head of financial planning at Killik & Co, says: “With them it’s about looking at the level of income they’re drawing from those accounts, and potentially thinking about the feasibility of that long term.

"If you do have increasing costs [you] perhaps need to be a little bit more cautious around the income strategy over the medium and long term.

“Where clients are drawing from defined contribution schemes, this is where it’s important to stress test any models that are built in for clients.

“The thing I would always say to clients is, we want a financial plan to be a worst-case scenario, because anything above that is a benefit. There’s no point in planning for the best-case scenario.”