Retirements are getting longer, which is of course a great thing.
Progress in medicine and greater awareness of how to stay healthy has meant people are getting more time in this world, on average.
It does however raise the crucial question of how longer spells enjoying later life without income from working can be financed.
In the latest of PA's Digital Working Lunch series, Baillie Gifford's Tom Danaher shared some insight on the options available, the issue of income volatility and the benefits of targeting long-term income growth over short term yield.
"At Baillie Gifford we think we need to completely reframe how we think about financial risk in retirement," Danaher told attendees. "Traditional measures are important of course, but the real and fundamental risk that individuals face is running out of money."
Investing and decumulation needs to focus more on that risk over the next decade as we all live longer and becoming increasingly dependant on our pension pots, he added.
He also noted the increasing scrutiny from the Financial Conduct Authority in this area.
Danaher said retirees should consider three broad options. They could opt for a fixed annuity, choose an Retail Prices Index-linked annuity, or stay invested by selecting an income drawdown product. "The question now facing the growing numbers of people approaching retirement is whether to lock in the high returns available from cash."
He explained that a fixed annuity would offer significantly higher immediate income than the other two options, while also slightly beating the other two on income 15 years into the future if inflation stays relatively low.
The ‘elephant in the room' however is that the annuity options do not offer any prospect of capital growth. With an income drawdown product, an initial pot would be likely to grow significantly over this time period, Danaher noted.
By way of example, Danaher said a £500,000 pot would turn into £767,716 over 15 years if conservative returns in line with inflation at 2.9% were achieved.
With longer retirements and uncertainty over inflation, it is becoming less clear whether opting for an annuity will be a better move than staying invested in the market. Retirees could be exposed to real terms income volatility over time, while having no capital left to sell down to make up any shortfall they face.
Instead, retirees could consider something like Baillie Gifford's Sustainable Income fund. Danaher said the product can smooth out long term income volatility using a multi-asset approach.
Funds such as this aim to pay an income today, while investing in a mix of equities, real assets such as property and infrastructure, and fixed income instruments to deliver income growth in the future.
