Adapting to the early retirement trend

6th September 2007

In this article Independent Financial Adviser and personal finance author Martin Bamford considers the main issues associated with early retirement planning.

The Government is currently considering a series of changes to pension rules. These proposals will have serious consequences for anyone considering an early retirement. They include a rise in the State pension age from 65 to 67.

These proposals follow recent pension legislation changes that mean an increase in the minimum age at which you can access pension fund benefits. You can currently take benefits from a pension plan at age 50. From 6th April 2010 this is raised to age 55. There is also a phased increase of the State Pension age for women taking place - from 60 to 65 years old.

These factors, combined with a more general mistrust of conventional pension plans as retirement planning vehicles, have caused many people to seek and consider non-pension alternatives.

Pension plans as a retirement planning tool come with some advantages as well as some drawbacks. Despite all of the modern features that have developed, a conventional personal pension plan still misses the mark for many people. The benefits you can take from a personal pension do not suit everybody and access to these benefits can still be restrictive. The new legislation introduced in April 2006 to simplify pensions did improve things, but there is still an inherent inflexibility when using personal pension plans for retirement planning.

The trend we are currently witnessing towards an earlier retirement comes as we are being told to work for longer and retire later. Early retirement is about personal choice and control. If we accept that a financially comfortable retirement at age 65 is becoming much more challenging to achieve than early retirement at, say, age 55 will require some quite sophisticated planning as well as potentially great cost. It will also require a good deal of determination to make this a reality.

The earlier this planning is done, the better. If the benefits of compounded investment returns (where investment returns are based on previous investment returns) are fully leveraged then plenty of time is required.

The specifics of early retirement planning will depend on your personal circumstances; namely your income, expenditure, assets and liabilities. The financial resources you plan to have available for an early retirement might come from a wide variety of sources; including non-pension investments, savings, a business sale or stake in a property - or possibly even inheritance.

Conventional retirement plans in the form of a personal pension are likely to be geared towards providing benefits at a much later stage than an acceptable early retirement age. In some cases this problem can be very easy to solve. Some of the more modern pension products allow you to bring your retirement age forward, in line with the minimum retirement ages explained earlier, without excessive penalties or charges.

Less modern pension arrangements and occupational pension schemes in general are generally harder to deal with. The result of taking early retirement benefits from these arrangements is, typically, a big financial penalty. If those plans contain a with profits investment fund then those penalties can be substantial.

There are lots of disadvantages to bringing forward your selected retirement age with a pension plan. One big drawback is the lower annuity rate available at a younger age. Annuity rates are partially based on life expectancy so they are better as you get older. You will receive a much lower annuity at 50 years old than you would at 65 years old.

It is also important to think about your investment risk profile. If your pension fund was originally invested with a twenty year time horizon in mind then you were probably tolerant of a higher level of investment risk. Shortening this time horizon by ten years or more will have an impact on how suitable those investment funds are.

If you do conclude that it is not appropriate to bring your pension fund retirement age forward then you could consider bridging the gap. This would involve building sufficient assets to provide an income between the early retirement age and previously selected retirement age.

This approach to early retirement planning actually requires less money than traditional retirement planning because you are trying to build up a capital sum that will be gradually eroded over a predetermined length of time. There are no concerns about building a capital sum and converting it to income.

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