I recently read an article by the ex-pensions minister, Steve Webb, here which held some interesting data about longevity and how it applies to clients spending their pension funds within the new flexible rules introduced by George Osborne in 2015.
With his permission I’d like to make you aware of some of the important statements in this article that I hope will help my clients, and anyone else reading this.
As a quick reminder, in 2015 ‘flexi-access rules’ were introduced to the pensions market which effectively allow you to spend your personal pension funds when you want and in the amounts you want. No longer do you have to trade in your pension fund for an annuity (a set income for life) and hope that you live long enough to get your money’s worth.
Instead, you could take as much or as little as needed, based on your needs and circumstances at the time.
When discussing the various options available to clients now for accessing pensions I’m finding that the new flexible access rules are generally appealing to far more clients than an annuity.
One of the features of flexi-access that clients seem to appreciate is that any unspent monies in your pension fund can now be passed on to your beneficiaries…and if they don’t spend it all then they can pass the fund onto whoever they wish (subject to various taxation rules dependent upon age of death etc).
As an Adviser I must say that the ‘flexi’-access’ rules has been one of the most helpful financial planning products I’ve ever been able to use with clients. It allows clients to really tailor their income to the quality of life they need year by year. When they need more, it can be made available and when they don’t it can remain in their fund and continue to grow.
However, I’m also finding that these new rules have introduced me to a whole ‘buffet’ of client attitudes about how people want to spend their retirement money….and I find the differences both exciting and worrying.
I have some clients who have more than enough to meet their needs but, no matter what I say or show them, I cannot get them to spend anywhere near the amount they can afford to – despite reinforcing that they are destined to be the richest person in the grave yard and that they will be leaving a potentially large bucket list unticked.
I also have clients who are destined to be penniless way too soon and nothing I seem to say makes any difference. When I tell them they are forecast to be living on the basic state pension of £153 per week and how this compares to their current lifestyle I just seem to be talking to myself.
So, what are the misconceptions and what are the FACTS that people need to consider when spending their pensions (regardless of their particular view of the world and how their money fits into it?)
Well firstly, almost all these challenges boil down to one factor – no-one knows how long they’re going to live. If we did then my job would be easy.
And while this can sometimes be a difficult issue to raise with clients, there are some important pointers that could help you avoid some of the pitfalls when thinking about life expectancy and the longevity of your pension pots.
What are the misconceptions?
The first big misconception comes from the figures we read in the newspapers for ‘life expectancy’. According to the Office for National Statistics, life expectancy at birth in England is just over 79 years for a man and just under 83 years for a woman. Any client turning 65 and hearing these figures might assume that their money only needs to last them 14 years if they’re a man and 18 years if they’re a woman.
But, of course, they’d be wrong. A lot of people don’t make it from birth to pension age – this decreases the average figure for life expectancy at birth. Amongst those who do make it to age 65, the ONS says that on average, men can expect to live for over 18 years more and women can expect to live around 21 years more. This is already 3-4 years more than the life expectancy at birth figures.
But there are two reasons why even these numbers could be misleading as a guide to how long you are likely to live.
The first is that there’s a link between wealth and life expectancy. As the ‘Cridland Review’ of state pension ages highlighted, even within a single city, there can be a difference of several years in life expectancy between the least and most deprived areas. If we assume that people who seek financial advice are on average better off than those who don’t, it would be likely that the life expectancy of clients as a group will tend to be greater than national average figures.
A second reason to be careful with the published figures is that there are two ways of measuring life expectancy – ‘period’ life expectancy, which takes account only of past changes in longevity and ‘cohort’ life expectancy which also includes projections of future changes. Many published figures are for ‘period’ life expectancy, so they don’t take account of the long-term improvements in life expectancy that we’ve seen in recent decades.
A good place to try and establish your own longevity is the ONS (Office of National Statistics) calculator, ‘What are your chances of living to 100?’ which uses cohort data and has the added advantage of giving not just average figures, but a likelihood of more extreme outcomes.
Once you have an idea of how long you’re likely to live my suggestion is to add a few extra years on. Personally I feel its slightly better to run out of years than run out of money – but without leaving more than necessary. If I manage to leave a few quid for my beneficiaries to tick off their bucket list’s then I’m happier with that outcome than the alternative – one of walking around supermarkets at 9pm looking for discounted food about to pass it’s ‘sell by’ date or watching the gas meter more than the TV!
By far the best tool to help clients understand the likelihood of either running out of money or dying with too much is a cash flow forecasting tool. A lifetime cash flow forecast allows an adviser to enter into a software program the value of your assets (and liabilities) together with the level of expenditure you need to cover your necessities (keeping a roof over your head and food in your belly) plus your leisure activities (going out for meals, holidays and the hobbies you’d like to spend more time on in retirement). Add in a few more ingredients such as inflation, realistic estimates of future investment returns together with any special events you wish to plan for and, hey presto, you will be faced with the most realistic computer image of whether you have enough or not.
As an adviser I find these tools so valuable. It’s a bit like having a time machine that allows you to look forward into a client’s financial future – and the best bit is, if you don’t like the outcome, you can come back to today and make some changes to see if this solves the problem.
It’s also important that cash flows are reviewed regularly. One of the few things that is guaranteed in a long-term financial plan is that it won’t be right. Inflation will change, investment returns will vary and, quite often, your desires of how to spend your money will change over time too. As an adviser I am offered a ‘window’ into people’s lives and their attitudes at varying ages. I’ve seen clients go from having ‘traveling the world’ as their priority in their 60’s to saying that their fed up with airports in their 70s and can think of nothing better than simply sitting at home with their grandchildren on their knee.
As a summary I think the key to living well and managing your retirement finances wisely (if you chose to use flexi-access) is to establish what’s important to you about money and how you can transfer figures from a valuation statement to something that’s of more value – whether that be world cruise or a trip to the local park with Grandchildren.
Secondly, have a realistic expectation of your longevity – and then add a few years on to ensure you don’t run out of funds.
Finally, engage an Adviser who uses cash flow tools and can help you to establish what REALLY is important to you so they can ‘marry your money to your meaning’ and help you get the best life you can with the money you’ve got.
Fore more information and to discuss your own retirement plans feel free to get in touch with me at firstname.lastname@example.org