The point is that we are living longer; yet we still expect to retire at the same age as our parents or grandparents. There seems to be a gap in reality where we think we can still retire at 60 or 65 and be able to fund a retirement of perhaps 30 years!
It’s easy to be focused on the present – BREXIT, Trump, China et al – and yet by doing so we won’t see things that directly impact our future well-being. Perhaps we don’t want to consider the future but in doing so we seem to be missing one of the biggest financial crises to hit us for decades; BREXIT, Trump and others will pass but this has implications for us for many years to come.
I am fascinated by calls for greater funding for the NHS; whatever side of the political fence you sit the somewhat naive idea is that the more money you throw into it the more likely you are to solve the crisis. However, the problem facing the NHS is much more complicated than many really understand (and I am included in this). But there are simple facts we can look at; when the NHS was set up medical care was less complicated with certain diseases being an instant death sentence, and added to this very few people were expected to live long in retirement.
It might be a surprise for some but time has not stood still. People are living longer, and the range of treatments are ever more complex and expensive. As an example, AIDS was a death sentence in the 1980s and can now be controlled by a range of drugs. Cancer is another example where more and more people are being cured. But this comes at a price, these drugs are not cheap and the funding of treatment is different. Some treatment can now have large up-front costs, others are funded over a long period of time. This was never factored into the blueprints for the NHS!
Although these changes shouldn’t be a surprise it seems that successive governments have failed to invest sufficient money into the NHS to reflect a changing society. Of course, it goes further but it is clear that throwing more money at the problem is just a sadly deluded thought. It is like a leaking dam which has been neglected for decades, you can repair bits but eventually it will break. I am no expert on what can be done but it needs something radical because just putting more money into the system will not develop an NHS for the future.
Strangely this blog is not about the NHS but something that faces similar challenges. “Retirement” used to be something we could look forward to at 65; in 1965 life expectancy was just a few years (age 72) and therefore it was something to be enjoyed. For many this meant they didn’t to worry about saving for retirement because guaranteed pension schemes were provided by their employer and on top of this was the state pension. Retirement was a predictable event; guaranteed income until death (which of course was not far away)!!!!!
But this has changed, it is now conceivable that retirement will last two to three decades (assuming we continue to think retirement starts at 60 or 65). At the same time funding for retirement has changed; it is estimated that by 2050 very few people can expect to be part of a guaranteed pension scheme. The government have tried to address this through the introduction of auto enrolment but there is an acceptance that this on its own will not be sufficient to provide for retirement. Longer life spans mean retirement lasts longer and costs money to provide for, not to mention potential long term care costs.
The difference between the NHS and retirement is that people are talking about how to fund retirement now and trying to consider what can be done to avoid a crisis in the future.
In this blog, I want to explore some of the challenges; I won’t look to provide solutions because as we will highlight that is much more complicated.
Surprisingly this isn’t something new however the implications of this seems to be ignored by many. In the UK, the average life expectancy of children born in 2013 is over 90 years’ old!
The point is that we are living longer; yet we still expect to retire at the same age as our parents or grandparents. There seems to be a gap in reality where we think we can still retire at 60 or 65 and be able to fund a retirement of perhaps 30 years! Think back just 50 years and we were talking about perhaps 7 years in retirement. It begs the question whether we should be expecting or considering retiring at 60 or 65.
The other crucial element to this is that in living longer it brings more complex health needs. Fundamentally retirement is no longer predictable with ill health, cognitive decline and reduced mobility having a significant bearing on how our retirement path progresses. Yet it seems most people don’t want to discuss this side of retirement, as the song goes “life is for living” and so we seem to think retirement will be!
It all sounds a bit depressing but having said that there is a growing number of people who don’t view retirement in the traditional sense. Perhaps they see it as a time to have a career break, or work part time; this seems to be the true changing face of retirement. It is conceivable that the new “retirement” age will be 80 plus because even at 80 it is potentially 20 years of retirement, and there are plenty of fit and healthy 80 year olds.
The funding trap
This one is perplexing for me.
Retirement for previous generations was somewhat simpler. It went something like this; we worked for perhaps one employer, they provided a pension scheme which guaranteed to pay us an income in retirement in addition to the state pension…easy. And in some cases, we didn’t need to pay into the scheme!
What is facing people today is very different. More young people are going to university meaning that they start they working life later and often with greater levels of debt. Renting after leaving university is now no longer cheap and purchasing a property seems out of reach for many and yet a long-held dream. What this means is that people are often not able to fund their retirement until much later in life.
Reading the FCA paper on an ageing population they highlight that auto enrolment is an important part of helping to fund retirement but it isn’t enough; they state that the 8% contribution of banded earnings is too low, and the DWP estimate that 11.9 million will be under saving! For many employers auto enrolment is great for profitability as there is no longer the burden of large pension contributions, and no real incentive to pay more than the minimum but obviously, it’s not so good for the employees.
The reality is that as individuals it is now down to us to save for retirement because no-one else is there to help! Yet all the evidence is that we are simply not saving enough; this is because in many cases we don’t have the means to do so, and equally many don’t want to consider an event so far in the future.
It is worth adding that assumptions of inheritance covering any shortfall may be a thing of the past, especially when we consider that our parents are now living longer in retirement and using more of the money they have built up; how selfish!!!
Ever more complex needs
Once we get our heads around the challenges facing funding then we are faced with retirement itself.
Many go into this assuming that it is easy. Pension freedoms provides greater control and access to our pension funds but they also land us with greater responsibility. Added to this there is an increasing move to cut out the middle man and strike out on our own; I often hear people say “let’s do it ourselves, it’s easy and saves us money”.
It’s not impossible to self-manage in retirement but there comes increased responsibilities; how much income do we need and how do we manage it, how do we manage the investments and what about funding health care etc. These are all valid questions when considering a retirement spanning 2 or 3 decades.
Take some examples; for those with a single pension pot of say £30,000 they may consider that cashing it in is the best route. However, there are things to consider; a proportion of the value paid might be subject to tax, if state benefits are being paid these could be reduced or stopped as a result of the payment. More significantly once the money is gone it is gone. With this in mind, it is worrying that this group of individuals are the ones more likely to cash in their pensions.
Another example is the annuity maze. It isn’t that long ago that a £100,000 pension pot would provide around £10,000 in income each year; today that is around £3,000 to £4,000. On paper, it seems that annuities are poor value for money. However, if life expectancy was 7 years then £10,000 might seem a good deal but you need to live beyond 10 years to gain the full value. With people living longer the odds have shifted; annuities must now last 20 or 30 years, and annuity rates have dropped to reflect that; £4,000 is about 25 years. The point is that they may appear poor value for money but they do provide a guaranteed income which could be for a considerable period of time. It’s all about perception.
Going further it wasn’t that long ago that drawing an income from a pension fund was considered high risk, however now it seems the norm. For example, someone with £100,000 decides they want to take £10,000 a year from age 65, if growth was 5% a year then the fund would be exhausted by the time they were 78. If they took £5,000 it would in theory last until they died. However, if they wanted to inflation proof the pension (assuming inflation was 2%), then £10,000 of income would last till age 77 and £5,000 till age 96.
A higher level of inflation can significantly reduce the number of years the fund lasts; if 3% would take 5 years off the £5,000 income this exhausts the funds by 91. Drawing income from the pension fund is not as straightforward as it seems, yet individuals don’t want to buy an annuity because they perceive it as poor value for money, but don’t consider the risks of the alternative options.
Just to add to the retirement maze the FCA indicates that older people tend to rely less on fluid intelligence and more on gut feel. This can lead to effective decision making but normally only in areas that they are familiar with. The FCA goes on to highlight that financial literacy in the UK is really poor and therefore making gut feel decisions in relation to money can have a detrimental impact. If an individual takes £5,000 a year (inflation linked) but then decides to buy a car for £15,000 at age 70, this would mean the funds run out age 90 rather than 96. Using a gut feel to buy a car (a depreciating asset!) may seem right at the time but the impact can be massive.
We shouldn’t ignore the investment strategy because this can also have a detrimental impact. If investment growth was 4% and inflation 3%, then £5,000 would only last until age 87. So even taking an income has to factor in any potential lump sums, inflation and investment growth.
The list goes on when we talk about income but other areas to consider are long term health care, tax planning etc. The point in all of this is that what the FCA have said is relevant because retirement is complex and just because we are experts in one field it doesn’t mean we are in others. A decision based on a gut feel can have a significant impact on our retirement planning.
Cash should be a blog on its own but it is worth including here because it is reflective of the mindset we are in. For many (including journalists) cash is seen as the place for savers, and true cash was once king.
To explain, when we retired with our guaranteed pension we got a lump sum. We were not expecting to live long in retirement and it made sense to put it into cash. The added bonus was that we could get 5% plus on our savings and this provided a top up to our pension as well as leaving something to the children.
But that has gone…these days retirement can last almost as long as a working life so why hold cash for that. Secondly and more importantly, cash held for nearly ten years has provided little or no interest and this is not changing anytime soon.
This comes down to education; whilst journalists are fixated on cash as the only means to save, we have a problem. Cash is a means to achieve short term goals but should not now be seen as a long-term savings plan.
We know that the NHS is struggling with ever more complex needs, and more funding short-term might be the answer but this is just like putting sticking plasters on a broken leg. It won’t fix it properly and doesn’t get to the root of the problem. A major overhaul of the NHS is required but this may involve privatisation which is not what the service was built on.
Education is a crucial part of tackling this problem. But there needs to be big changes in the way we think. Perhaps retirement is more likely to be at age 75 or 80 and not 60 or 65. Perhaps there should be greater incentives for us to save, and for employers to pay more for their employees. And we need to understand that although Pension Freedoms is a reflection of changes in society it brings its own challenges. With all the questions the great thing is that we are talking about it now and it gives time to develop something for the future. If we do nothing, then like the NHS it will be too little too late and we really will be working until we drop dead!!
Note: This is written in a personal capacity and reflects the view of the author. It does not necessarily reflect the view of LWM Consultants. The post has been checked and approved to ensure that it is both accurate and not misleading. However, this is a blog and the reader should accept that by its very nature many of the points are subjective and opinions of the author. Individuals wishing to buy any product or service as a result of this blog must seek advice or carry out their own research before making any decision, the author will not be held liable for decisions made as a result of this blog (particularly where no advice has been sought). Investors should also note that past performance is not a guide to future performance and investments can fall as well as rise.