As the industry gears up for the introduction of retirement freedoms in April what will people choose? Stephen Lowe goes through recent research into what retirees are looking for.
George Osborne's ‘freedom and choice in pensions' reforms may be good politics, but will they turn out to be good policy? The full consequences will only start to be seen once real retirees with real money start making their choices from April next year.
In the meantime, all businesses keen to thrive in the new pensions environment are trying to understand how consumer behaviour is likely to evolve and what solutions will best meet their needs in the future. Of course, a good way to find out more is simply to ask tomorrow's retirees what they would like to do with their money. The problem with that is that the complexity of pensions makes it a lot easier to gather opinion than genuinely useful insight.
This real need for in-depth understanding prompted us to undertake our most ambitious research project, targeted specifically at a diverse group who were all within 12 months of taking pension benefits.
All those attending were required to complete and bring along an assessment of their current and likely regular expenditure in retirement plus up-to-date statements of their State, occupational and private pensions.
These were real retirees from different areas of the country with varying mixtures of final salary and defined contribution pensions who were thinking about how best to deploy real pension money to meet real bills, similar to the kind of conversations professional intermediaries will be having with their clients in the coming months.
In a series of face-to-face, household (with partner) and individual depth interviews lasting around 90 minutes, we explored their knowledge of their retirement choices and attitudes towards each option. Most importantly, with the help of computer modelling, we were able to instantly feed back to them the impact of their decisions on their likely future income and to ‘road test' some of the features of the new products likely to be launched under the new rules.
Before talking about the key themes from the research, it is worth giving a bit more background on what modern retirees are like. All those we interviewed were expecting to receive State Pension plus some extra income, typically between £6,000 and £15,000 a year, from other pensions.
Nearly all were looking forward to the future and most were phasing into retirement by cutting down the number of days worked per week with about a quarter planning to work into retirement. Most had heard of the reforms but were sketchy on the details. Two-thirds had started worrying about their finances in retirement. All were aware of the 25% tax-free cash entitlement and intended to take it, but only those with the smallest and largest pensions were contemplating taking more at the outset.
One of the key themes that emerged from this cross section of retirees was the fundamental desire by all to maintain their current standard of living in retirement. Having enough income in retirement to pay their way was the priority over leaving an inheritance. The strong desire not to lose what they had was reflected in the fact that the majority described themselves as low risk or no risk investors. Even the wealthier ones who were ‘hands on' with more capacity for loss were low to medium risk. When investing in later life it appears loss aversion is far more important than growth aspiration.
There was an innate understanding all would be largely reliant on the income produced by their pensions for an unknown number of years, so it had to be used wisely - there were no Lamborghinis on order. Three in four clearly described their requirement for having guaranteed income to cover their regular outgoings, allowing them to budget from month to month.
Most got the idea quickly from the fact that we had asked for details of pensions and likely expenditure that the session would explore how their regular income would stack up against their regular bills. This resulted in a simple mental model of layers of income with State Pension as the foundation, secure final salary benefits on top, then income generated by defined contribution arrangements used as the top up where required.
It was only once they had reached income to expenditure equilibrium that they saw the value of having more flexibility with any remaining pension savings. One concept that found favour was a "flexible access" facility within the pension environment which could be invested, for example, using risk-rated funds, guaranteed funds or a fund supermarket. They liked the convenience of a one-stop shop with a broad range of options.
In most cases the flexible access facility, although still part of the pension, was viewed in a similar way to non-pensions savings and property (private residences or buy to let) some may hold outside the pension environment. Rather than income generating assets, these were seen as sources of funds for emergencies, big ticket items (holidays, cars, house renovations) or for helping out other family members either during or after their lifetimes.
When they did consider the flexible access facility in terms of income, it was primarily as a way to purchase further chunks of secure income later in life to ensure that their income and expenditure maintained equilibrium or, to put it another way, re-balancing for inflation.
New types of retirement solution
Although the new rules were not finalised at the time of the research, we knew enough to give them a glimpse of the opportunities for new types of guaranteed retirement income solution, such as those providing income that can vary - down or up - to better fit spending patterns in retirement.
There was interest in two guaranteed income ‘shapes' in particular - the first with income that ‘steps up' after a period of time which appealed to those who planned to keep working part time, the second a ‘flying start' that gave a higher level of income in the early years when the retiree saw themselves as more active than they would be in later life.
The research backs up the idea of the ‘prudent' pensioner but also reinforces the important point that there can be no ‘one size fits all' retirement income solution. Everyone taking part was an individual, with different plans and aspirations, different knowledge and different financial circumstances. That said, most were becoming more familiar with online tools and the need to do some background research themselves even if they later planned to take professional advice or guidance.
Pension reform was something they were following and some had loose plans about what to do with their money. By far the biggest stumbling block faced by the whole research project was that many of those targeted chose not to take part because of the difficulty - perceived or otherwise - of having to gather in advance information about their existing pensions.
This is more compelling evidence of our current ‘two tier' system in which informed consumers tend to secure good outcomes while those who are less engaged lose out. If the reforms are going to work, this second group will need to become far more engaged or improved consumer protection will need to be implemented by the FCA to change pension firms' sales practices that currently fail to address the most common errors made in the inertia-driven purchasing environment.
For those who did take part, what was both surprising and pleasing - and bodes well for professional advice and guidance - were the high levels of genuine enthusiasm during the sessions to explore the options. Although just a matter of months from retirement, most really hadn't yet given their decisions any detailed thought or taken action such as seeking State Pension forecasts. Yet they were genuinely fascinated by the financial analysis and modelling as it unfolded in front of them, and interested in the detail.
Perhaps we shouldn't have been so surprised - we were talking about their money and their aspirations and few things capture people's attention like being given a glimpse of the future.
Stephen Lowe is group external affairs and customer insight director at Just Retirement
Three years at Wells Fargo
Effective from 9 December 2019
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