With greater choice comes greater responsibility
28 Apr 2021
Over recent years we have seen a move towards increased choice being offered to individuals around their finances. This includes the move away from Defined Benefit (“DB”) pensions towards Defined Contribution arrangements (“DC”) and, in the last five years, the introduction of pensions freedom and choice. This places a lot more responsibility with individuals to make decisions over their retirement savings.
To understand more about consumers’ retirement expectations, we conducted a survey on over 1,500 consumers aged 50-65. They were asked about their expectations of their pension pots, how they think these pots will be used and the risks that they believe they are most exposed to.
The results of the survey showed that the majority of consumers had some form of plan in place for retirement but still felt that there was a lot of complexity around pensions, in particular understanding the material impact of longevity and investment risk. This suggests more can be done to help educate consumers on pensions in order to help them navigate the decisions that they need to take for better retirement outcomes.
Retirement income levels
On average, respondents expected to have £212,000 in their pension pot when they retire, with large differences seen between males’ and females’ expectations (Males: £270,000, Females: £139,000). When asked how individuals expect to fund their retirement, the majority stated that the State pension (69%) would be their main form of income, followed by their own savings and other financial investments (46%). With the State pension being identified as the main source of income in retirement for the majority of people, it is important to understand that for many this may not provide the standard of living that they expect to have.
Given that three in five respondents said that they believe their income in retirement will match their expectations well, it is important to look at what this expectation means in more detail. The table below shows a modified version of work carried out by the PLSA that quantifies styles of retirement, which has been tailored to the questions asked in our survey. It shows three scenarios that respondents said best described what they expect their savings to provide them with at retirement.
|What standard of living do you expect to have?||Covers all needs, with some left over for fun (27%)||More financial security and flexibility (40%)||More financial freedom and some luxuries (19%)|
|House||-||Keep home maintained||Replace bathrooms or kitchens every so often|
|Personal||Cover the cost of some new clothes||Replace car every few years||Replace car every 5 years plus a sizeable budget for new clothes|
|Holiday & Leisure||Holiday once a year somewhere in the UK plus a few nights out a month||Couple of weeks' holidays a year in Europe||
Go on holiday for three weeks in Europe each year
40% of individuals expect to have a reasonable standard of living from their retirement savings with sufficient income to provide them with financial security and flexibility to be able to fund holidays, new cars and home repairs. Therefore, it is crucial that individuals understand the level of income that will be necessary throughout retirement to meet these expectations.
The work carried out by the PLSA sets out three distinct levels of income to support the standard of living individuals aspire to having in retirement, indicated above. The table below sets out the target income levels for each lifestyle. These income targets are based on a single retiree living outside London. The PLSA have issued different target incomes for those in couples and for those living in London, where costs are slightly higher.
|What standard of living do you expect to have?||Target income level|
|Covers all needs, with some left over for fun (Minimum)||£10,200 per year|
|More financial security and flexibility (Moderate)||£20,200 per year|
|More financial freedom and some luxuries (Comfortable)||£33,000 per year|
These results can provide a useful benchmark for individuals to frame their retirement planning as well as providing them with a target to measure their pension pot projections against and make adjustments where necessary in order to achieve their retirement goals.
Estimating life expectancy
Longevity risk is a material consideration in setting viable retirement plans but isn’t often something that consumers will take into account. Retirees struggle to estimate the number of years that they might spend in retirement and are generally unaware of the financial significance of underestimating their own longevity.
When considering how long respondents think their pension pot will need to last them, it was found that, on average, people estimate they will live until they are 82 years old. Given that they have or are expected to retire at an average age of 64, this means that respondents have an expectation of living for 18 years after their retirement on average. In reality, the average life expectancy for males aged 64 is 88 years old and for females of the same age is 91 years old, showing an underestimation in both genders by several years which can have huge financial consequences.
The struggle individuals have in assessing their longevity and the scale of the problem can be highlighted by the 21% of respondents who said they do not think they will live until their 90s. The reality is that 50% of those aged between 50-65 are expected to live into their 90s.
Where longevity risk gets even more difficult for individuals is the need to understand the variability around their own life expectancy. The difference in planning horizon can have a huge impact on the outcomes for an individual and pose a real risk to those in retirement not having enough saved to last them. An example of this risk can be illustrated by an individual, who is retiring at age 65 with £100,000 in drawdown. If they decide they want to have an income of £3,800 per year and choose to only plan for a 20-year time horizon, the likelihood of the fund meeting their goal is 70% under a fairly low risk fund. If, however they add on another 5 years onto this time horizon, the likelihood of the fund meeting their goal is reduced to 20%, showing the impact living longer can have on an individual’s retirement finances.
The survey also examined what caused people to think about their retirement planning. Most respondents said that it was due to them being a few years away from retirement. This is worrying for many as this timeframe would be too short to make any significant changes to their pension provisions that might be necessary. Therefore, we know people would benefit by taking earlier actions in their working life to achieve a better standard of living in retirement. The challenges that respondents are now facing could have been mitigated by decisions earlier on in their working life, and indeed, 31% of our survey respondents said that they wished they had saved more in their 20s and 30s.
How we can help
As we have seen through the results of the survey, more can be done to help engage and educate individuals to manage their risks and successfully plan for retirement. One way that actuaries can help is by creating tools to help frame the problem in an understandable way.
By creating these tools we can help individuals to understand the importance of correctly assessing their longevity and investment risks in retirement. The scalability of guidance tools mean that they are also a cost-effective way to close the advice gap where we have seen a reluctance and inability for individuals to afford the financial advice that could prove so important in managing their risks in retirement.
Retirement planning tools can help individuals gain greater insights into the nature of risks, in particularly the variability of them. Through stochastic modelling we can show visual representations of what might happen in different scenarios both in terms of life expectancy, investment returns and a combination of these. This enables people to understand the risks more clearly and determine whether the potential outcomes fit with their personal goals and risk appetite.
One such example of these is our Guided Outcome™ tool. It allows the user to project their pension pot to retirement to see what their potential retirement income could be if they continue contributing at current levels, or if they increase contributions, change retirement age or adjust investments. With this tool, we have seen 37% of users take action in order to meet their goals at retirement.
Across the market we see that digital guidance tools are becoming an important aid that can help individuals become more informed about their needs and risks and hence be able to make smarter decisions that best meet their own retirement goals at a time when they are being faced with increasing levels of choice around their retirement finances.
How Hymans Robertson can support you
Hymans Robertson has a wealth of experience in retirement products and digital wealth management tools to help with retirement planning conversations. We can provide support to ensure you help your consumers plan for their retirement effectively. If you wish to discuss this further, please do get in touch.