People retiring today could be forgiven for feeling a little short-changed.
We’re now a decade beyond the beginning of the financial crisis. However, the extent of its impact on our long-term retirement planning is only now becoming apparent.
In fact, research from Fidelity (August 2017), shows a mixture of low interest rates, rising inflation and sluggish wage growth, mean those retiring today will be, on average, 46% worse off than those retiring 10 years ago, in 2017.
With experts predicting things to get worse before they get better, exactly how bad will it get? And more importantly, how can those on the verge of retirement deal with the problem?
The research also reveals that a typical pension pot could provide an annual income of:
- £12,193 in 2007
- £6,607 in 2017
One of the key reasons for this difference in over just 10 years is the relationship between earnings and inflation. Between 1997 and 2007, average earnings rose by 3.5% per year. This kept pace with inflation, which averaged 2.6% over the same period. The following decade saw average pay rises drop by nearly half. Over the same period the rate of inflation for this period averaged 2.7%, meaning many employees effectively suffered a pay cut (Source: Fidelity August 2017).
The slowdown in wage growth had a knock-on effect to pension contributions which, combined with other factors, meant pension pots were smaller:
- People retiring in 2007 had a pension pot worth £180,107 (Source: Fidelity August 2017)
- People retiring in 2017 had a pension pot worth £139,110 (Source: Fidelity August 2017)
This 29% drop, was exacerbated by lower Annuity rates, meaning that those retiring today will see just over half the annual income of those retiring 10 years ago. (Source: Fidelity August 2017)
Why are Annuity rates so low?
Insurers link Annuity rates to the yield on long term UK government bonds, commonly known as gilts.
Unfortunately, for the hundreds of thousands retiring over the past decade, gilt yields have continued to fall year on year. One of the primary reasons being, that in the wake of the financial crisis, the Bank of England cut interest rates and bought billions of pounds of gilts as part of a Quantitative Easing policy designed to prop up the economy.
When gilt yields fall, Annuity rates fall, reducing the available income for those pensioners who choose to buy an Annuity.
In some ways, Pension Freedoms, introduced in 2015, will solve this problem. The number of people buying an Annuity since 2015 has dropped considerably, with more people preferring to turn their pension pot into an income using Flexi-Access Drawdown (FAD), which leaves their pension pot invested, meaning the problem of lower Annuity rates is avoided. However, the use of FAD brings with it its own issues, not least the fact the capital remains invested and exposed to a degree of investment risk.
How to deal with the problem
Whilst Annuity rates aren’t expected to improve soon, there are a few options available to reduce the impact on your retirement income.
Use Flexi-Access Drawdown: Before 2015, one option for dealing with low Annuity rates was to hope they eventually recovered. When Pension Freedoms were introduced in the April 2015, more options were made available.
Pension Freedoms allow those over 55 to be more flexible.
Rather than simply buying an Annuity, savers can opt to leave their money invested in the pension, taking money as and when they need to. FAD does come with greater risk; the value of your investment can rise and fall, and it can be difficult to ensure the level of withdrawals are sustainable.
Disclose your health: If an Annuity is still the right option for you, for example because you want a guaranteed income, disclosing your health is crucial to getting the best possible rate. Those with severe health conditions often overlook Enhanced Annuities, and many are unaware of them entirely. An Enhanced Annuity is essentially an increased income that factors in a shortened lifespan due to a range of illnesses including:
- Alcohol or smoking-related conditions
- High cholesterol
- High blood pressure
- Circulatory or breathing difficulties
- Heart attacks
Shop around: All Annuity providers offer different rates, and there can be huge differences between the best and the worst. Contrary to popular belief, you don’t have to purchase your Annuity from the provider you have been saving with, so ensure you know the market before making your choice.
If in doubt, get advice
Since 2015, most pensioners opted for Drawdown rather than an Annuity (Source: FCA July 2017). Whilst this option offers flexibility, and allows for money to remain invested, it also carries risk. Not only is there risk from market fluctuations, but also the potential to run out of money if you spend too much or live too long.
For more information about making the most of your income in retirement, or for advice on constructing a solid portfolio, don’t hesitate to get in touch using the phone number at the top of the page.