"It should not be used to maximise retirement income, this will only cause further debt problems and limit solutions a few years later."
Wilkins Micawber, in Dickens’ David Copperfield, says: “Annual income twenty pounds, annual expenditure nineteen and six, result happiness. Annual income twenty pounds, annual expenditure twenty pounds ought and six, result misery.”
There are many things that can influence a person’s spending, in Wilkins Micawber’s world their expenditure. What is essential to one person could be regarded as a luxury to another. It is not possible to generalise - everyone’s spending is different.
If Wilkins Micawber was commentating on retirement spending in modern-day terms he may come out with, “Retirement income is £12,000 a year and annual retirement spending is £11,900, the result is a happy retirement. Retirement income is £12,000 a year and annual retirement spending is £12,100 a year, the result will be an unhappy retirement.”
Over 40% of new equity release plans are used to pay off debt. This means that many are living an unhappy retirement before turning to equity release.
In a pension freedom world, how can I talk of retirement income? Surely people can adjust their income to meet their spending? However, not all have a pension pot and those that do may not have as much in it as they would wish.
A very rough rule of thumb is that an inflation-proofed income has a chance of surviving a lifetime, if withdrawals begin at between 3.5% and 4% of the available fund. This means that someone with a State pension of £9,000 a year needs a minimum of £75,000 in their pension pot to get up to £12,000 a year; £150,000 to get beyond £15,000 a year.
Currently a single life annuity for a 66-year-old that did not increase in payment would produce around 4.3% income or 2.75% if income is going to increase at 3% per annum.
Now consider someone with employment income as they approach retirement of £35,000 per annum, just under the national average salary. How will they adjust to a retirement income of £15,000 a year? Let alone £12,000 a year.
Will they be able to cut their spending so that it just below their income? What will they give up and will giving up things result in a happy retirement? For many, if they cease working before State pension age, they will have to fund their State pension until it becomes payable.
Another rule of thumb focuses on the proportion of earnings a person requires in retirement to maintain their living standards. At lower incomes it is often stated that around two-thirds is required. This reduces for higher incomes. Again, this is very individual thing.
Working from home has shown that getting to and from employment costs money. However, there are those who before the crisis already worked from or near home. For them retirement will not produce the expected savings.
As people approach retirement, we can coach them as to how to reduce their spending to live within their new income. How successful will such coaching be? Even if we pair them back to spending at a level that is within their retirement income, for how long will that last? What happens when a large unexpected bill comes in? Cars, boilers or even roofs don’t last forever.
This is how many arrive at the equity release market. Debts keep growing, until something must give. The period over which the debts are growing is not synonymous with a happy retirement. When debts get out of control, there is worry; sense of failure; and loss of self-esteem. Often this can lead to mental illness.
How much better it would be, if people realised, they may have an asset that can be used to avoid such problems? Their house can be used to improve their income and meet those unexpected bills. It should not be used to maximise retirement income, this will only cause further debt problems and limit solutions a few years later.
The house should be used in retirement to improve financial resilience. The Money and Pensions Service (MaPS) have a responsibility to improve financial resilience in the UK.
Currently MaPS have several working groups looking at a strategy for achieving their financial resilience objectives. Hopefully, a key outcome will be to inform those who are retiring with limited retirement savings about how they may be able to use their housing wealth to avoid an unhappy retirement.