Back in the 1940s, when the State Pension age was set at 65 for men and 60 for women, the average life expectancy for males was just over 60 and, for women, 66. Therefore, although its introduction was hugely significant at its inception, in many cases the pension would not be paid for a very long period – or at all!
The demographic shift to a much older population has dramatically accelerated over the last 50 years. Official data suggests that one in three children born in the UK in 2020 are likely to reach the age of 100.
Perhaps, more alarmingly, in a recent ad campaign, Prudential suggested that the first person to live to 150 is already alive today. The pace of change seems to show no sign of slowing with each generation expecting to live ten years more than the previous one.
Savings plans such as pensions were developed in an era where the typical retirement might only last a few years. Now it could be 30 or 40 years. While it’s great news that people are living longer, everyone now needs to think about how they will be able to support themselves financially in a potential 100-year life.
In The 100-Year Life: Living and Working in an Age of Longevity, Lynda Gratton and Andrew Scott say: “The simple truth is that if you live for longer then you will need more money. This means either saving more or working for longer.”
Most people will struggle to make their retirement savings last their lifetime.
In their book, Scott and Gratton give the example of a man born in 1971 with a life expectancy of 85. Assuming that he wants to retire in 2036, at the age of 65, on a pension worth 50% of his final salary, he would need to save 17.2% of his income each year.
This is unlikely considering that between 2000 and 2005, the group with the highest savings rate in the UK (50 to 55-year olds) only saved 5.5% of their annual income.
Furthermore, these challenges are generally faced with less help from employers. In the mid-90s, virtually all of the FTSE 100 companies offered lucrative Final Salary style pension arrangements to their employees. There are currently no companies in the FTSE 100 that offer Final Salary pensions to new joiners.
The truth is that most people are going to struggle to make their retirement savings last a lifetime. A major World Economic Forum study across six nations has predicted that women will, in particular, bear the brunt of a severe cash shortfall against a backdrop of increasing longevity.
In the UK, the study found that men were, on average, likely to outlive their savings by 10.3 years. For women, it was 12.6 years. So, what can be done to bridge the gap?
Rethinking the way that ‘retirement’ works
Historically, there has been a three-stage life model:
One of the consequences of living longer and therefore potentially working longer to provide future funding, is that the transitions between each of these stages are likely to be more fluid. Individuals are likely to retrain or return to the education phase more regularly, and many ‘retirees’ may continue their careers well into what would be viewed as their normal retirement years.
How can you prepare for this new landscape?
It is essential to set realistic goals and plan your retirement. The use of lifestyle or cash flow model planning can help considerably in designing a suitable strategy. This provides an assessment and projection of your assets, income and expenditure over your lifetime.
The results will help you visualise the shape of your financial life, identify any potential shortfalls and build in any changes which are extremely likely over such a long period of time. It is the cornerstone to building a successful financial strategy.
Your personal model can build in the likely changes to your expenditure in retirement. How a client prepares for possible future care costs is often cited as the change that causes the most anxiety, especially as the cost of care has escalated significantly and is likely to be required for a longer period.
Preparing for these additional future costs, by incorporating them into your planning well before they come to fruition, will significantly improve the chances of your finances catering for them successfully.
The use of a cash flow model will also assist you in understanding whether you are taking an appropriate level of risk to achieve your goals. As you get older, the receipt of income and ensuring you preserve capital become more important, and traditionally investors move into less risky assets as they near retirement.
In time, it is likely that investors will keep a higher proportion of their assets in equities for longer, considering how long the savings are to be put aside. Identifying the rate of return to achieve your financial goals using a cash flow model is a huge planning advantage.
The importance of structuring your assets so that your income and capital can be received tax-efficiently cannot be overstated; net of tax receipts are more important than gross return. An individual can receive tax-free income and withdrawals of up to £31,500 per year, without including ISA or tax-free pension withdrawals. This doubles to £61,300 for a married couple.
Organising your savings to take advantage of these allowances will improve the prospects of your funds lasting through your lifetime.
The demographic changes are likely to encourage greater innovation in financial product design to deal with the problem. Already we are seeing improvements in product innovation for those wishing to take career breaks or retrain. Products are likely to evolve that will help people to withdraw money at other life stages, following in the footsteps of the Lifetime ISA. One area that is likely to continue to develop is the release of equity from their property. Property is often people’s largest asset and further developments in the lifetime mortgage and equity release market are therefore very likely.
The most dramatic change that we have seen in product innovation is in the pension market. These changes have already begun with the onset of Pension Freedoms and the declining popularity of annuities. Products which combine drawdown with annuities could emerge, enabling you to ensure your money keeps growing whilst also reducing your exposure to risk.
In addition, depending on how Inheritance Tax (IHT) rules change, more and more people are likely to use non-pension assets to fund their retirement. If you have assets above the current IHT threshold, then it can make sense to use these assets before drawing a pension, as the pension can be tax efficiently passed on to the next generation as beneficiary drawdown. This can be entirely tax-free if untouched and you die before the age of 75 or taxed at the recipient’s marginal income tax rate if you die after 75 as illustrated below.
Helping you to live a great 100-year life
Our aim is to provide clarity and peace of mind whilst preparing your assets and financial planning for your current and future needs. A sound financial plan which is regularly reviewed and monitored is a significant piece of the puzzle for a secure future.
We can help you ensure your savings are enough to generate the lifestyle you want throughout your retirement. Please send us a message via the HFMC Wealth website or call us on 020 7400 4700.
Philip provides a very client focused service. He helps individuals and families form and implement a suitable financial plan which he continually monitors to ensure it adapts to their changing circumstances.
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