7 things you should do in the three years before retirement

If you are planning to stop working in the next few years, there’s a lot to think about.

So, to help you to plan for the next phase of your life, we’ve put together a list of seven things you should do in the years before you retire.

1. Consider timing

Traditionally, people considered retiring on or around their 65th birthday. However, changes to the ways you can take your pension mean that stopping work is now much more flexible. The days of a ‘cliff edge’ retirement and one final day in the office are long gone!

You can now access your pension from age 55 and spend as little or as much as you like, however you like. Many people are choosing to wind down slowly – perhaps by taking on a different role in the business or working part-time – while many retirees end up returning to work a few years into their official ‘retirement’.

The result of increased flexibility has been greater complexity. As you now have more options, more decisions need to be made. The timing of your retirement could be based on:

  • Your family situation
  • Your income and future income aspirations
  • Your health
  • Whether you want to continue to work in the same or a different capacity.

Think about when – and how – you intend to retire.

2. Think about your goals

What type of retirement do you want? In the run-up to your retirement you need to start thinking about your goals and aspirations. Planning how you will spend your retirement will help determine how much income you’ll need.

A Sun Life survey reported in the FT found that five out of every six over-50s still have things to tick off their ‘bucket list’. You might have grand plans for your retirement, so thinking about how you are going to afford to accomplish these goals is something you need to do now.

Consumer advice charity Which? spoke to thousands of retirees about their outgoings. On average, they spent around £2,220 a month per household, equivalent to £27,000 a year. For a little more luxury, including long-haul holidays and a new car every five years, their research suggested you’ll need income of around £42,000 a year.

Planning ahead will mean you can save appropriately to achieve your goals.

3. Repay debt

The lifestyle spending figures above make one important assumption: you won’t carry a large amount of debt into retirement.

If you have any debt, especially high interest borrowings such as credit cards and overdrafts, you should try and repay these before you stop receiving a reliable income from employment. Repaying the mortgage on your home, if possible, is especially important.

Repaying debts before you retire means your pensions and other savings can go solely towards their intended purpose; fulfilling your desired lifestyle.

4. Work out where your income is coming from

It’s unlikely that your retirement income will come just from pensions. An Office for National Statistics report found that more than one-fifth of pensioner couples’ income came from earnings as more people work longer, in more flexible roles.

Income sources in 2017/18 included:

In the run-up to retirement, consider all your savings and investments and establish exactly what income you can expect to receive when you finally stop working.

5. Set aside a rainy-day fund

During your working life, experts recommend that you retain between three- and six-months’ expenditure as an emergency fund. This should be held in a readily available cash savings account and it’s designed to cover both unexpected expenses or everyday essentials if you lose your job or are unable to work due to long-term sickness.

A rainy-day fund to cover unforeseen costs is also important in retirement. Whether the boiler breaks or the washing machine floods your kitchen, having readily accessible cash means your lifestyle won’t be affected.

If your pension remains invested and you are taking a flexible income, it’s also good practice to use cash reserves during times of volatility. Making withdrawals from an invested pension when markets are down means you need to sell more units (and therefore more of your pension pot) to receive the same level of income.

6. Make sure your money can outlive you

Budgeting is important at every stage of life. However, recent research by Zurich amongst retirees currently taking flexible pension income showed that just 34% had calculated how much money they need to cover day-to-day living expenses.

Worse still, just 22% had budgeted how much they need to pay non-essentials too, such as going out for dinner or going on holiday.

A recent Financial Times poll found that 72% of financial advisers said their clients’ biggest fear was outliving their pension savings.

Failing to budget runs the risk that you run out of money to cover even the essentials. Statistics from Royal London show that just half of people in drawdown have a high likelihood of the income lasting their lifetime. So, after budgeting your regular expenses, you need to consider how long you’re likely to live, and plan accordingly.

7. Take steps to reduce Inheritance Tax

Inheritance Tax (IHT) is charged on the value of your estate when you die. It’s currently at a rate of 40% and there are two ‘Nil-Rate Bands’ available, up to which you don’t pay IHT. These are:

  • The Nil-Rate Band, which is currently £325,000 per person
  • The Residence Nil-Rate Band, which is currently £150,000 and set to increase to £175,000 in 2020/21. It was introduced to help you pass your home on to family. To benefit from this additional allowance, you must pass your home (or a share of it) to your children or grandchildren.

If the value of your estate is more than the Nil Rate bands, there are several ways you can reduce or eliminate a potential tax bill. To pass your wealth on to loved ones, rather than the taxman, options include:

  • Writing a will – according to Royal London, 59% of UK parents either don’t have a will or it’s out of date. Not only will your estate be distributed how you want, it’s a very simple way to reduce a potential tax bill
  • Leave everything to your spouse – If you’re married or in a civil partnership and leave your entire estate to your other half, they will pay no IHT. Better still, they will also inherit your unused Nil-Rate bands. Under current rules, that could mean their total IHT exemption is as much as £950,000
  • Give it away – gifting any kind of asset is exempt from IHT if you live for seven years after making the gift
  • Use your Annual Exemption – you can gift up to £3,000 a year using your annual IHT exemption. This gift is immediately outside of your estate, removing concerns about the seven-year rule mentioned above. It also rolls over a year if you don’t use it in the previous tax year, so you could gift up to £6,000 at once
  • Use a trust – if you put assets in trust, you are nominating them for the benefit of another. There are lots of different types of trusts in the UK designed to fulfil different purposes, one of which is mitigating IHT
  • Give to charity – if you donate to charity or include a donation in your will it’s immediately exempt from IHT. As an additional incentive, if you leave 10% or more of your estate to charity, the IHT rate is reduced from 40% to 36%

The earlier you plan to mitigate Inheritance Tax, the better. Unfortunately, not everyone is taking this advice. Over the past decade, the amount of Inheritance Tax paid has more than doubled to £5.2 billion in 2017/18 with around one in 20 estates liable for this tax.

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