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if we don’t tackle what is happening now it will be the norm for many.
In the final blog of three which started with the naked pensioner, now I want to consider the risky pensioner.
Much of the focus has been on those saving for retirement and not on those who are ‘at’ retirement.
Even these individuals need financial education, perhaps it is in our nature to complain and moan but what they say and do impacts on the generations coming up behind them. This generation, if the papers are to be believed, are the hardest done by.
The past
The past was perfect:
1. Risk – we were taught not to take risk in retirement. There were good reasons for this if retirement was perhaps 5 years why risk our investments for such a short period of time. The ultimate low risk investment was cash. In 2000 this would give around 6% interest a year, for those lucky enough to have £100,000 that gave around £6,000 a year interest
2. Pension – for many final salary pension scheme members that meant, and still means, that there were no worries about income in retirement. It was guaranteed to be paid until death! And what’s more it increased each year and contained a spouse’s pension….’lovely jubbly’.
For those less fortunate who had to fund their own pension, even around 2000, a fund of £100,000 would give a pension of around £10,000 with escalation and spouse’s pension.
3. Other benefits – of course the state pension came in at 60 for women and 65 for men and subsequently we have seen free prescriptions, bus travel, winter fuel allowances etc .
Don’t get me wrong, for many pensioners retirement is incredibly hard but this is not the norm. But if we don’t tackle what is happening now it will be the norm for many.
Correct thinking
The pension many receive now ‘is what it is’.
For those facing the dilemma today on what to do it is very hard. The government’s gimmick has not helped. So for someone who is 65 today with a pension fund what are the options.
1. Pension income is decreasing – the headlines complain that annuities are poor value for money. The reality is that the company providing the income has to do so for the person’s lifetime. Looking back 15 to 20 years, that lifetime was considerably shorter and therefore they could pay more on the basis that individuals would die sooner (sorry that’s the reality!) and the cross subsidy would fund other annuitants.
If on average our life expectancy is 20 years plus, something has to give. The company providing the income has to make the money last longer to ensure that they can fund the payments. The only way to do this is to reduce the rates used to calculate the pension income.
There are other factors but this should not be missed by anyone, and it seems to be missed by all the experts when they talk about it.
Annuities can work for many because although they seem low, they are guaranteed. Every month the person knows what they will get, and they will get that until they die!
2. Forget annuities – there are two options – the government option will enable individuals to take their whole fund as cash. Sounds fantastic but the reality is harsh. If someone has £100,000, and takes 25% tax free, they will be paying 40% on the remainder of this fund. Assuming they have no other income the tax will be nearly £20,000! Leaving a fund of around £80,000. It still has to deliver an income and assuming a 5% return this is around £4,000. This would not be much different from taking £100,000 and buying an annuity.
One other point to consider with taking the cash is that it will form part of an individual’s savings which could impact on benefits and be held against nursing home fees. And for those with larger pots of money it adds to the inheritance tax liability.
It is worth remembering that to get a return of 5% will mean taking risk, more than likely this can only be achieved by investing in equities.
The second option is drawdown – the individual decides on the income level say 5% of the fund which would be £5,000 a year. This amount is not guaranteed and the individual needs to manage the investments of the fund (or pay someone to do it for them). Assuming retirement of 20 plus years this is a continuous cost for management.
The point is that for individuals who are making retirement decisions now it is very challenging, but it reflects that those retirement choices aren’t the same as they were even 20 years ago. We can’t expect to enjoy the same retirement for longer for free.
Taking risk
The train of thought for those reaching retirement has been to take all risk off the table. It’s obvious we want to enjoy retirement, not worry about it.
1. Cash – cash is king for those in retirement. The FCA and many leading writers point to cash as the lowest form of risk. You cannot lose money; your capital is always there. For those in retirement this is important. A fear of losing capital is paramount.
However, interest rates on cash have effectively meant that cash is and has been a negative asset for over 5 years. Pensioners who rely on cash to provide their income in retirement have seen this wiped out.
They complain bitterly that they have not benefited in the low interest rate environment and believe that the sooner rates go up the better for them. The reality is that when they go up it will be slow, and banks will not be quick to share the benefits with customers.
Pensioners have to accept that cash rates will be low for a long time to come.
2. Reverse thinking – if we were 45 and looking to invest for the next twenty years where would we invest. The obvious answer is equities; no-one in their right mind would invest in cash for the next twenty years.
However, when we reach retirement we are trained to think cash is king and that is what we do. If we knew we were facing 20 years in retirement (which potentially we will) then investing in cash is crazy. Equity investing doesn’t have to be risky if the mind focuses on the long term outcome.
Pensioners complaining about low interest need to understand that everything has changed. We accept that for some it is too late to do anything but for others it is different. Over the long term equity markets will provide above inflation returns and can deliver income. We just need to accept that the risk which we face is all part of the game, and that risk isn’t all bad news either – it’s just painted that way (cash can’t bring home the bacon!)
The risky pensioner
The risky pensioner is the one who focuses on the past, holds their money in cash and waits in the hope that one day it will get better.
It might get better but not to the levels of 15 years ago.
The prudent pensioner focuses on the future and won’t be stuck in the cash trap. These pensioners can help the generation saving now to think about how they approach retirement and it is these that we should turn to as forward thinking individuals.
The challenge for the FCA, journalists and others is how we educate pensioners and others on how they face retirement and the choices they make. If we get it right with the generation retiring now it will help those just starting out.
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. This is not a recommendation to buy any product or service including any share or fund mentioned. 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.