Retirement – do the public and the government really have a clue?
Two headlines have cropped up in the financial press recently that suggest that we are heading for yet another retirement income disaster. These are both taken from the New Model Adviser on the 3rd November 2015:
“Pension Freedoms: Savers withdrew £4.7Billion since April” and “Pensioners to run out of cash by age 75, report warns” (For the full articles, please visit http://bit.ly/1Q5enhX and http://bit.ly/1SnVvJz).
I do not think I am being too rude by saying that most members of the public have no idea about mortality risk or the time value of money. Most people are not very good at evaluating risk of any sort, which explains the popularity of The National Lottery and gambling in general.
The annuities that people have been avoiding, “as they are poor value for money”, deal directly with mortality risk and can, if bought with the right options, also deal with the time value of money. I suspect that with knowledge and time, people will come back to them as a solution to a retirement income problem!
Mortality risk is the possibility that you might live longer than your money; annuities pool the assets of a large number of people, so the early deaths subsidise the late ones, reducing the cost to the pool as a whole and eliminating the risk of running out of income.
The time value of money is not so obviously handled by annuities as most annuities are sold on a “level basis”, with the same income every year. The time value of money recognises that inflation will undermine the value of money in future years, with £10 of buying power now being worth considerably more than £10 in ten years time.
To give a physical example think of the Mars bar; in January 1987, a standard Mars bar was 20p. By July 2011, it was 49p, so you would need nearly two and a half times more income, 24 years later, to buy the same thing. Given current life expectancy and the usual retirement age, you would not have to be too fortunate to have a retirement that lasts longer than it took for a Mars bar to more than double in price. (http://www.mei.org.uk/files/conference12/a2_2012.pdf).
You can buy annuities with escalation, so the income received over time rises, rather than stays the same. The catch here is that the cost is higher than a level annuity and calculated so that if you have a normal life expectancy, you will only have a 50:50 chance of profiting from it.
Much as I applaud the Pension Freedoms as a force for good, they must also be seen as a scary black hole for the ignorant, the rash and the unlucky. There is no substitute for either learning what is important for long-term retirement income or paying us to design your retirement for you.
Contact me with queries
If anyone is looking for general advice, then please write in to the blog and I would be happy to help with anonymous advice posted here. Alternatively, please call us on 0116 253 5600 and ask to speak to an IFA, (Independent Financial Adviser), for a no-obligation discussion.
If you know you need formal advice, have a look at http://bankfield.net/personal/retirement-planning/, or ask around for a recommendation, it might even be me.