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Retirement is changing
Philip May
April 27, 2022
KEY TAKEAWAYS
- Retirements are getting longer but more complicated. Since the introduction of Pensions Freedoms in the UK in 2015 individuals have more choice about how they access income in retirement, but this comes with a requirement for more engagement from the retiree.
- The UK retirement landscape continues to evolve. Future retirees will derive a greater proportion of their retirement income from Defined Contribution plans, throwing more responsibility onto the individual. Rising inflation is likely to increase the need to hold growth assets in retirement portfolios.
- Retirees should be able to choose either flexible advised solutions or robust default solutions to create sustainable and adequate income streams. In both cases, greater focus by providers on financial education will help investors make well informed decisions and understand their retirement finances better.
Retirement: a new world
How often have we heard friends or relatives say "I'm really looking forward to retirement"? And then paused to wonder whether any of us have really thought carefully enough about all the implications of retirement, especially the financial ones?
How can people who are about to make the leap into retirement be sure that their retirement income will not only cover basic expenses but also fund the extra activities which make life enjoyable?
Recent decades in the UK have seen an accelerating transition from a retirement which was quite well defined - at least financially - in advance, to one which has a lot more variables and alternative outcomes. We can expect this trend to continue and possibly intensify in the future.
There has been a very welcome increase in the emphasis placed on the importance of extra savings for retirement, and a default structure to support the accumulation period. This paper focusses on the decumulation phase, which in our opinion, requires a deeper understanding, further development of suitable product offerings across the wealth level spectrum and more education aimed at individual investors both before and after retirement.
Retirement: a changing backdrop
We're all familiar with the demise, outside the public sector, of the Defined Benefit (DB) pension but we may forget that it not only gave a pension payment linked to final salary but that the payments were, at least since the introduction of the Pension Protection Fund, in effect guaranteed and included some protection against inflation. Therefore, not only secure income but income secure in real terms. Against a backdrop of volatile stock markets in recent years, and now rising inflation, investors who must increasingly rely on Defined Contribution savings face significant uncertainty.
UK inflation has recently reached 7.0%1 and inflationary pressures are likely to be with us for some time to come. This reflects not only shorter-term issues such as COVID-related supply shortages and higher energy and raw materials prices, but also longer-term factors such as workforce shortages.
Today’s retirees need to consider not only what their income in retirement buys today, but what it might buy in years to come. As the proportion of DB income declines in comparison with DC income, this will become an increasingly pressing problem with implications for the optimal design of retirement drawdown portfolios.
If that isn't enough, retirees are increasingly recognising that they might need to fund 20 to 30-years or more of retirement living. Latest data from the UK’s Office of National Statistics show there is a non-trivial chance of having a 30-year retirement for people retiring at 66. In fact, by 2045 the number of people aged 85 years and over in the UK is projected to reach 3.1 million2.
1. UK CPI inflation rate for the 12 months to March 2022. Source: ONS
2. As at 12 January 2022. Source: ONS
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