Since the pension reforms of 2015, investors have a greater degree of flexibility and choice when accessing their savings. Significant though the reforms were, they have to be seen within the context of other changes affecting retirement, particularly demographic developments.
Accelerating life expectancy
Accelerating life expectancy means that a 65-year old man in the UK has an average of 18.5 more years of life ahead of him, while women of that age will live on average for another 20.9 years, according to the most recent data from the Office for National Statistics. These are averages, of course – someone could live for just one or two years in retirement, but there’s also a growing chance that they could live to 100. A retiree with sufficient savings to get them to 85 could still be left with an empty pension pot if they live beyond that point.
It may be surprising to learn that people tend to misjudge how long they are likely to live. A study recently showed that those aged 55-70 significantly underestimate their chances of surviving to greater ages. As a result, they may fail to take the required measures to prepare for a longer retirement.
Another error that people can make is to overestimate the level of income they can expect in retirement. Research has shown that in some cases the average income is considerably less than the amount they’ll need to be “financially comfortable”.
There may be many unexpected demands made on savings in retirement, including those from ongoing debt repayments such as mortgages, financial support for children and long-term care. These can be substantial.
From DB to DC
The decline in defined benefit (DB) (known also as Final Salary) schemes – when many workers retired with the security of an income until death – has created difficulties. Due to insufficient private pension provisions and rising life expectancy, the move to defined contribution (DC) (known also as Money Purchase) schemes has placed far greater responsibility on individuals for their pensions.
Considerations for planning
Careful planning needs to take into account investment risk, inflation, the risk of expenditure such as long-term care and mortality drag. Mortality drag refers to the need for drawdown investments to work harder – as investors become older – if they’re to provide the same income as an annuity. Unlike those annuitants who live longer than average, and who benefit from the cross-subsidy inherent in risk pooling, drawdown investors don’t have pooled risk in place.
Annuities: still working hard
This is why annuities – though waning in popularity – remain an important component of the at-retirement product suite. Investors are more likely to enter drawdown when they reach retirement. But an annuity option remains open to them, and may become attractive if maintaining a sustainable income from drawdown proves too demanding.
Ageing and decision-making
Another feature of ageing is its tendency to bring about cognitive decline. This can affect people’s abilities both to make decisions and to seek help with making decisions. And that includes financial decisions. Yet, despite their cognitive decline, people’s tendency to be confident in their decision-making remains. This is an important but difficult subject to bring up with clients. Cognitive decline, dementia and Alzheimer’s disease will affect more people as longevity increases.
Awareness of the challenges
Being aware that living longer brings many financial risks is not enough in itself to solve all the problems. But it’s a sound basis on which to build a robust investment strategy.
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