Retirement Income: the risks… and the questions to ask?
24 July 2012 | John Davis, Technical Development Manager
Life is full of risks and the current emphasis seems to be on eliminating risk rather than managing it.
We all face risks each and every day. For example, you have a meeting with a client and there is a risk that when you travel to the meeting you may be involved in an accident. But then there is a different risk if you don’t attend the meeting at all, as you may not secure the business. And with this approach, eventually you could run out of money and risk losing your home and so on.
So risk is with us all the time.
But, what specific risks do retiring clients face, in terms of their retirement income?
For some of course, there is limited risk. They reach retirement age and their employer provides them with an inflation-linked pension of half their salary payable for life and a nice lump sum to do with as they wish, and an income for their dependant when they die. The numbers of people in this position is falling each year with increased job mobility and closure of final salary related pension schemes.
Successful clients may well have accumulated what appear to be large pension funds and of course the logical starting point is to show them what income their fund will provide, with of course, an inflation-linked pension. This then provides an income which keeps pace with the general rise in prices and is effectively the no risk option.
The problem here is simply that the starting income is likely to be well short of their expectations. Depending upon age at retirement, their annual income could well be between 2% and 3% of the pension fund they are planning to annuitise. So for example, providing an annual income for life with 100% spouse benefit, of around £3,000 a year, to a married couple both aged 65 would require a fund of around £100,000.
This is the nearest to a ‘no risk’ retirement solution. Your client is understandably unimpressed with this level of income so at this point they enquire as to the other options available to them.
Now the options we know are wide and varied but in simple terms, the next question to ask is: “What sort of risk do your clients want to take?”
Of course, many clients will simply say they do not wish to take any risk, but that option has been discounted on the basis of cost. So, it’s back to the question of risk. And specifically, inflation risk and the investment risk.
Buying a level income for life provides a higher income but exposes the client to inflation risk, something beyond their control but something most current retirees are well aware of.
Investment risk is more complex, more immediate but not necessarily as bad as it initially may seem certainly when compared with the other risk.
There are now a wide range of investment solutions, from investment linked annuities through the wide range of options now available through pension drawdown, including fixed term annuities which effectively provide perhaps the best of both worlds, underlying guarantees but without the inflexibility of a lifetime annuity at current historic low levels.
In reality many clients expose themselves to the inflation risk without necessarily considering the long term impact such a decision may have.
John Davis, Technical Development Manager