The pension’s landscape in Britain is changing. From the 6th April 2015, anyone who has been saving into a pension scheme, come 55 years of age, is now free to do whatever they want with their full pension pot. However, the challenges for people approaching retirement haven’t changed. Everybody wants to feel secure in the knowledge that they can: generate the income they will need, make their income keep up with inflation and make their pot last for as long as they need it to.
Finding the right sources of income is difficult
In the past, finding sources of income that paid a meaningful income was relatively straightforward but, in this low-rate environment, it is much harder. In fact, of the 2,000 people we interviewed for our Investor Pulse survey[i], eight in 10 baby boomers said they don’t know where to find the best income-generating investments.
Inflation may be low now but it rarely goes away for long
The average rate of inflation over the past 30 years has been 3.3% per year[ii]. And, while inflation is less of a concern than it was even one year ago, it rarely goes away for long and therefore it is likely to continue to eat away at our wealth over time. For example, £1,000 five years ago now has the spending power of £853[iii]. Yet, the average Brit has two-thirds of their assets sitting in cash according to our survey, which means the majority of their wealth is persistently declining in purchasing power.
We’re living longer
In 1985, a 65-year-old man would have been expected to live another 13 years, according to the Office for National Statistics. In 2015, that estimate is 19 years. Similarly, a 65-year-old woman’s life expectancy has gone up from 17 years in 1985 to 22 years in 2015.
So, what should investors do?
Our survey found that more than a quarter of baby boomers approaching retirement are likely to stay invested in their pension plan, taking regular withdrawals and using part of it to purchase an annuity. But an even larger number (28%) are undecided about what action they will take. This hesitancy is not surprising given the new options and the challenges they will face in making the right decision with probably the largest pot of money they’ve ever been in charge of.
3 main actions
BlackRock’s top 3 actions for those approaching retirement are:
1. Understand the pension changes, the tax liabilities you could incur and take the free retirement advice offered by the government.
The pension reforms mean that people can retain control of their assets rather than automatically hand them over to an annuity provider. But this does not mean that all the money can all be taken out in one go tax-free. Everybody is entitled to take out 25% of their pension pot tax free, any amount above that could be liable to tax, which is why it’s important that people seek the free guidance offered by the government or speak to a financial adviser.
2. Decide what minimum annual income you can live on in retirement.
Nobody wants to live a subsistence level existence but it is still important to understand how much income is required to pay for life’s essentials. Once this has been established, you may want to allocate some of your pension pot to ensuring these costs can be met throughout your retirement. Annuities also pose a difficult choice at the outset: either you can have a higher level of income which doesn’t rise with inflation, or a lower level of income at the start but which does keep up with inflation. Whether you go down the annuities route or not, it is important to apply this kind of cold realism to how much income you need and whether this will be sustainable.
3. Make a financial plan and regularly review your retirement savings approach.
Annuities can still form an important part of retirement provision. They guarantee an income and can also be set to rise with inflation. But these guarantees come at a cost. Buying an annuity means giving up your capital. If it is important for you to keep a portion of your pension savings, you will need to find different investments to provide your income. There is a vast array of income-providing investments, spanning from fixed-term bonds to funds which invest across all assets classes (multi-asset). What is vital is weighing up whether your investment approach will give you the combination of income, inflation protection and longevity you will need.
Having stability and security in retirement is something we all want. But it requires planning and it requires action. If we want our money to last, we need to put it to work. If we want it to generate a meaningful income, we cannot afford to leave most of it in cash. And if we want to make the most of the pension freedoms, we need to take control – whether that is asking ourselves the cold hard questions about what we want for our futures and making a plan or taking advice.