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 by the Pensions Policy Institute (PPI) that was sponsored by State Street Global Advisors (SSGA) 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.
There is a growing chance that people could live to 100, and this has major implications for savings.
Another error that people make is to overestimate the level of income they can expect in retirement. The average income they can expect is 27% (£6,445 p.a.) less than the amount they'll need to be "financially comfortable" according to research by Opinium.
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. In England, for example, the average residential and nursing care costs are around £700 and £1,000 a week respectively.
From DB to DC
The decline in defined benefit (DB) - 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) 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 - as ABI research shows - 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. It's "one of the most challenging intergenerational issues facing the investment industry", according to a report by SSGA.
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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Iain McGowan is Head of Fund Proposition at Scottish Widows. For further insight and expert guidance, please visit Scottish Widows Change Hub
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...