A pension was originally designed to be a deferred income, and somewhere along the way this has been forgotten. It’s time to cut through the noise and get back to basics. Guaranteed income for life, when presented as part of a portfolio of income streams, still meets this original brief.
We know that people are retiring differently now. The original purpose of a pension seems to have become a bit lost along the way. It’s time to get back to basics.
A pension was originally designed to provide a means of saving for an income in retirement, in older age. This might be when someone is semi-retired, but is predominantly when salary stops. It’s supposed to be deferred income.
It was meant to be a vehicle to save income each month (accumulation stage), to be taken as income in later life (decumulation stage). Putting a secure foundation of guaranteed income in place has a lot to be said for it. Does anyone really want to experience what it could be like to run out of money?
Putting a secure foundation of guaranteed income in place has a lot to be said for it. Does anyone really want to experience what it could be like to run out of money?
Increasingly people are using a mix of continuing to work, property and investments to provide income in their older years. Keeping this sustainable though is another matter, as retirement can last a very long time, and on average the longer you live, the longer you will live.
This means income provision needs to stretch further than many people think. For example a 65 year old female has a 50% chance of living to 89. However, wind this forward to age 89, and the same person now has a 50% chance of living to 94. Assuming she survives to 94, she then has a 50% chance of living to 98. And on it goes.
Short term thinking is becoming pervasive, and could leave a generation of younger retirees struggling in later life.
Does this mean we are storing up problems for the future?
Today’s 55 - 59 year olds will be on the tail end of many DB schemes. As the death knell sounds for final salary schemes, this group of retirees will become more dependent on money purchase and property than the baby boomers that went before them. The fact that old DB schemes were cast in stone meant that members were forced into longer term thinking for income provision. Today’s easy access mentality towards DC pensions means that tomorrow will never come, and today’s short term needs can be met first at the expense of the future.
It might be stating the obvious, but accessing pension pots at ages 55-59 for short term non-retirement financial needs could mean retirees are left short of capital in ‘later’ retirement. The Money Purchase Annual Allowance (MPAA) restriction that kicks in could mean that they are unable to save enough if they were looking to ‘restock’ their pension provision in a significant manner before retiring ‘properly’.
The ‘short term thinking’ issue isn’t helped by the inconsistent approach of consecutive governments. There is state advocacy to compel people to join a workplace pension, as it was recognised people need to save for an income in retirement, but then there is a complete hands-off approach at the other end. A shrug of the shoulders and mutterings of ‘it’s your money, do what you like with it’.
Consider also that the state pension underpin is getting pushed further and further out time-wise for future generations. The increase in drawdown sales and the seismic shift in ownership of longevity risk from providers to the individual, is leaving people vulnerable to outliving their retirement income. It’s like putting a safety net in place, by saving into the pension in the first place, but then cutting a great big hole in it and hoping for the best.
The sustainability conundrum
If a retiree is looking for true flexibility, then having the ability to pick and choose from a portfolio of income streams, must be the way forward. Having a mix of invested and guaranteed income sources that can be turned on and off at different times, as state, workplace and private pension benefits come on line provides a solution that can adapt as retirement income needs change.
In order to tackle the conundrum of longevity and therefore sustainability of income, a guaranteed income for life provided by an annuity can provide the underpin needed. When paired with a range of investment vehicles it enables other invested funds to grow whilst income can be controlled for tax efficiency and access to additional lump sums remains.
However, the framing of a guaranteed income for life needs careful attention. All too often they are cited as standalone products that are inflexible and offer poor value. When the opportunity of increased income rates, if you have a pulse and a postcode, and the availability of death benefits are considered, this becomes a far more attractive proposition. Not only do they provide a longevity hedge, but the rate of return for a no risk product is often close to the elusive sustainable income figure that many look for.
If you said that the income from a £50,000 annuity was £2,500 per annum, this might be viewed as not competitive. But if you said ‘would you like a 5% return for the rest of your life, however long that might be?’ it suddenly attains viability as an income stream.
Summary
The range of possibilities that were unleashed with pension freedoms can be potentially overwhelming, and finding a suitable solution can be something of a puzzle, where no one size fits all.
Stating that using pensions for what they were ultimately designed for, and providing an income in retirement is perhaps counterintuitive in the modern retirement landscape, but for many retirees this is exactly what they need. Having the peace of mind of a guaranteed income that will never run out can provide the foundation that all other plans are built on.
For advisers, this means carefully piecing together a collection of income streams for retirees during the transition away from salary and into self-dependency. This is where a guaranteed income for life fits perfectly into modern retirement portfolio thinking.
Tony Clark
Proposition Marketing Manager
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