Test Your Retirement Planning Knowledge

Traditionally, the idea was that an employee had a secure job until retirement, and was then given a comfortable pension. Over the years, the security around pension provision has gradually been eroded, and there is an increasing burden on individuals to make their own pension arrangements. Retirees often have to make a trade-off between a guaranteed but low retirement income, or a higher income that entails more risk.

Online retirement calculators come in many forms. Some are very basic. Others over-simplify the underlying assumptions. Yet others, most notably EvolveMyRetirement, provide invaluable planning assistance to individuals.

Almost all investments entail some degree of risk. When you invest in stocks and shares, the value of a company can sometimes skyrocket, but it can also sometimes crash. Even fixed-interest investments have risk, since the issuer might become insolvent and unable to continue payments.

There are many different types of bond, though. Some are issued by governments, some by companies. Some are short-term, some long-term. Some pay interest regularly, others pay it all at once at the end of the term. Many bonds can be bought and sold, much like stocks and shares.

ISA stands for Individual Savings Account. It can be used to hold either cash, bonds or shares. The owner has no tax to pay on any income or growth of the ISA holdings, and can access the funds at any time.

Most pension plans are able to offer a tax-free cash withdrawal of a percentage of its value at retirement. The remainder of the plan can either be used to buy an annuity or else remain invested and gradually drawn down, in both cases generating taxable income.

Under the new UK pension freedoms, retirees are no longer obliged to take their pensions as annuities. They can now choose to keep their pension pots invested, and make gradual withdrawals over their lifetimes, which are treated as taxable income. This is known as pension drawdown.

The 4% rule was created by William Bengen in the USA, to determine a 'safe' withdrawal rate for retirees. It was only ever intended as a rough guide, and the actual safe rate will depend on many factors specific to the retiree.

To be eligible for the new State Pension, you'll need to have paid National Insurance (NI) contributions for a minimum number of years. The amount you get will also depend on your NI record.

Retirement planning involves making future projections, taking into account a number of variables that for all intents and purposes are random. These include things like how long one actually lives, and year-on-year market fluctuations. Using Monte Carlo simulation, we can measure our confidence in the likely success of a retirement plan.

The two broad categories of pension plan are:

• Defined Benefit: The employer takes the market risk. Retirement benefits are determined by salary and length of service.
• Defined Contribution: The employee takes the market risk. Retirement benefits are determined by the investment performance of the contributions.

Fortunately, slavery has been abolished, so no government can force anyone to keep on working. Anyone of any age who has accumulated sufficient wealth, and is able to access it, can choose to retire at any time.

The figure of 25% applies to personal pensions. Different rules may apply to some other types of pension plan. You should consult a qualified financial advisor before withdrawing funds from your pension plan.

Investment styles can be broadly subdivided into 3 groups.

• Cautious: Avoids most risk with the expectation of only modest returns.
• Balanced: Takes moderate risk with the possibility of good returns.
• Aggressive: Takes high risk with the possibility of high returns.

With compound interest, money in a savings account grows exponentially. This is a great way to accumulate wealth for the long term, as long as interest rates are higher than the rate of inflation. Unpaid debts also accumulate compound interest, often at uncomfortably high interest rates. This means that not paying them off early can lead to severe financial problems later on.

An annuity can be bought with the accumulated proceeds of a pension plan, in order to generate a regular income in retirement, guaranteed until the death of the retiree. You can also choose to buy an annuity for cash. The older you are, the higher the possible annuity income you can get.

On average, women outlive men in every country in the world. This is only a statistic, though. Individuals of either gender can have widely varying life expectancies, depending upon their family histories, states of health and lifestyles.

Over the years, your retirement income will need to keep pace with inflation. One way of achieving this is by having index linked annuities. The downside is that these can be expensive, particularly for younger retirees.

National Insurance (NI) was designed so that employees build up their entitlement to state benefits, including retirement benefits, over their working lives. After retirement age, no further NI contributions are required, even for people who continue to work.

Inflation in most countries is measured by a Consumer Price Index (CPI), which tracks prices changes for a basket of consumer goods and services. The UK also sometimes uses a Retail Prices Index (RPI), which is based on a more restricted basket of goods and services.