Retirement planning and pension arrangements
What the exam tests
Domain 6 covers retirement income needs, pension structures, accumulation and decumulation. Questions test replacement ratios, defined benefit versus defined contribution schemes, contribution limits, longevity and inflation risk, and sustainable withdrawal.
Core rules
- Replacement ratio: target 70–80% of pre-retirement net income for a similar lifestyle, adjusted for lower work costs and higher health costs.
- Defined benefit (DB) promises a formula-based pension, often indexed; defined contribution (DC) depends on contributions, returns and fees, with investment and longevity risk on the member.
- Project in real terms or inflate consistently; do not mix nominal returns with today's spending.
- Longevity risk: plan to age 90–95, or use annuities or pooled arrangements for tail risk.
- Sequence-of-returns risk matters in early retirement; a poor early market can permanently damage a withdrawal plan.
- The 4% withdrawal rule is a rough starting point, not a guarantee; it assumes a diversified portfolio, long horizon and specific fee and tax conditions.
Worked example
Pre-retirement income is 80,000; a 70% replacement target is 56,000. State and employer pensions provide 20,000, leaving a 36,000 gap. At a 4% initial withdrawal rate, required capital is 36,000 ÷ 0.04 = 900,000. Current retirement savings of 300,000 grow at 5% for 20 years to 300,000 × 2.653 ≈ 795,900, leaving about 104,100. Annual savings needed at 5% over 20 years (annuity factor 33.07) are about 3,150. The plan is feasible only if contributions, returns and fees match the assumptions.
Traps
Using 100% of final salary; ignoring inflation and fees; assuming average returns equal actual experience; forgetting survivor and health costs; starting withdrawals without a cash-flow buffer.