Retirement income planning for those with insufficient pension savings

Andy Haldane, Chief Economist at the Bank of England, created a stir when in a recent speech he said he did not understand pensions and that from conversations he had with many experts and financial advisers they did not either.

Related topics:  Retirement
Bob Champion
30th June 2016
Bob Champion, LLA, Later Life Academy
"A large proportion of those currently retiring are going to have to call upon other savings and investments which invariably means their housing wealth."

When it comes to funding retirement income I wondered if he was inspired by a blog published in the US by Prof Wade Phau. In his blog, Wade distinguishes between ‘Probability’ and ‘Safety First’ techniques to retirement income planning. He identifies 36 techniques that are in use in the US today - no wonder the blog opens with the comment that retirement income planning is “still in a state of flux”.

In the UK many of the 36 techniques have merit. Variations will result from different tax and social security (which includes state pension) rules, combined with product availability and investment opportunities.

Probability-based techniques can be summarised as those that look at the risks of investing for retirement income and aiming for an outcome using simulation techniques. An example of these techniques would be safe withdrawal rates, using at drawdown a fixed withdrawal rate to a given investment portfolio with simulations indicating that after a period of time e.g. 35 years, there is a probability e.g. 90% chance of not running out of money.

Safety first approaches start from with the question, ‘How do you guarantee an income for life?’ There are different degrees, of Safety First techniques. The extreme would be to use the entire available fund to purchase an annuity.

36 techniques is a large number and there are academics still searching for a holy grail. Financial advisers will have their own views as to what techniques are best suited to whom.

When it comes to setting up investment portfolios clients are assessed against their attitude to risk and their capacity for loss. Is it enough to then apply these outcomes to one or more of the 36 techniques that the adviser feels suitable or are more required?

Probability-based approaches depend upon risk being taken with the sequence of investment returns and longevity. Safety First approaches depend upon giving up capital in return for collective insurance e.g. an annuity. How can an adviser ensure that his customer understands what is being discussed?

Probability-based approaches can be adapted to react to circumstances and the introduction of a secondary annuity market will enable a second chance solution for safety first solutions albeit at a price.

However what if clients do not have sufficient pension savings to meet their needs? A large proportion of those currently retiring are going to have to call upon other savings and investments which invariably means their housing wealth.

How do you factor that into a lifetime retirement income plan? For savings and investments you can factor in drawing down tax-free amounts using Capital Gains Tax and ISA rules. But what about housing wealth? Do you assume an amount, say 25% of the house equity, will be available for retirement income?

How is the housing wealth to be realised, through downsizing or releasing equity? Will it be used in parallel to pension savings to smooth sequence of returns risks in a probability technique or to supplement an annuity in a Safety First technique? Alternatively will the housing wealth only be called upon when pensions and other savings have expired? This does however restrict the Safety First techniques available to generate income needs during the early years of retirement.

Finally, it would be remiss of me not to mention those who are in receipt of Means Tested Benefits. How do you ensure they receive the maximum value of the pension savings they have accumulated? More importantly, how do you ensure that they do not slip into means tested benefits? A small level annuity sitting on top of a modest state pension will eventually be overtaken by Pension Guarantee Credit which increases in line with the state pension, i.e. currently increasing in line with the triple lock.

The smaller the pension savings the more complicated the advice issues become. Andy Haldane should, despite his lack of understanding, be able to retire comfortably on his pension savings. However for others it is going to be a complicated task to produce sufficient retirement income from their accumulated wealth.

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