Could segmenting the retirement years and earmarking assets to create income in stages remove the uncomfortable longevity guessing game?
In what has been a momentus year for pensions, EY's manager EMEIA insurance Dan Mahony (pictured) offers his insight.
If the rumours are to be believed, Osborne’s annuity moment was cooked up by a handful of people at the Treasury just weeks before the budget.
Such are the quirks of UK policy making that we may never know what their intentions were or to what extent they fully understood the impact of their measures.
However, this much seems clear: the proposals are popular and must be delivered on time (in an election year). And it will fall to the industry to ensure that it is prepared for the evolving decisions which customers might make in retirement.
Much has been written in broad strokes about the ‘mass market’ – in truth, as advisers know better than anyone, all of the 600,000 people who retire each year have their own individual retirement ‘journey’, their own priorities, concerns, commitments and plans.
As such, we must be a little careful about the value of making sweeping assumptions. But, following on from Steve Webb’s assertion that we’re all welcome to fritter away our pension on a sports car, what guesses can we make about ‘generation Lamborghini’?
According to Auto-Trader, to even consider second hand ownership you will need the best part of £80k – so allowing for tax free cash and the income tax bill, you probably need a pot around the £100k mark to get you started. Putting aside worries about how you then pay for petrol, how has this group behaved until now?
The 2012 Mintel figures suggest that of the 412,000 annuities sold that year, less than 26,000 (only 6%) were for greater than £100,000.
Compare this to the drawdown figures for the same year of around 40,000 and it seems a reasonable conclusion that the vast majority of this segment has already been seeking alternative retirement income propositions.
A parallel bank account
So will anything change? In effect, the government’s proposals boil down to the blanket removal of the Government Actuary Department (GAD) limits, which briefly threatened to throttle drawdown as a proposition.
Perhaps we should think about a pension as a parallel bank account (within a handy tax shelter) from which income can be drawn as and when needed – admittedly a little simplistic, but illustrative of how many customers are thinking.
In our view, it will be useful to segment the retirement years in to defined life stages, agreed with customers at outset, with a view to managing their total assets accordingly.
UK retirement propositions have traditionally (as a result of legislation) been unable to meet one of the most common profiles of income needs of customers in retirement: the ‘inverted bell curve’, reflecting higher income needs in the early active retirement years, a fall back through later life, followed by a rise again when care needs arise.
The liberalisation of the rules should make it more possible to plan for scenarios such as this, however in truth the position is more complex: most wealthier clients will have other assets to consider, including the equity in their home, and there are profound consequences of aggressive asset depletion during the early years of retirement.
There are also disincentives for prudence, not least in the funding of long term care, where remaining crystallised assets will fall foul of the means test.
In reality, even those with a relatively large pension pot will be unable to create sufficient sustainable income to maintain their lifestyle in to retirement.
The lure of withdrawing heavily in the early years may be too much to resist and perhaps easy to justify when you don’t know how long you are going to live. In this scenario, the individual could look to housing equity to create future income, either by downsizing or through equity release. In addition, we believe there could emerge a market in insuring against longevity in later life.
As an example of the kind of product that might warrant further exploration by insurers, a customer could purchase a 20 year pure endowment product, to protect against the possibility of living beyond (say) 85. Using a number of relatively conservative assumptions, by locking away £15k of pension savings at 65 you could create a maturity amount of more than £40k at age 85.
For customers with common impairments to life expectancy, this could be increased to almost £70k. Assuming stable interest rates and forecast mortality improvements, these maturity amounts could be turned in to lifetime income of circa £6k and £10k respectively.
The sum could therefore potentially be used to create ongoing lifetime income, or alternatively could remain in the pension fund, sheltered against the current long term care means test and earmarked towards legacy.
This type of construct would allow the customer to manage the rest of their assets towards depletion at a set date, rather than playing the longevity guessing game – a ‘sleep well at night’ tonic for clients.
For the wealthier, a key consideration will continue to be ensuring that the income they take will be as tax efficient as possible. In this regard, there may be increased demand for phased retirement products which facilitate incremental withdrawal of tax-free cash (through multiple crystallisation events).
By segmenting the retirement years and earmarking assets to be used in stages to create income (including some insurance against longevity), customers will be able to better maintain their lifestyle whilst retaining the potential to preserve legacy.
One thing seems certain, the rule changes will increase the need for those with significant assets to seek advice and professional planning throughout the ‘in retirement’ years.