Us­ing the pen­sion free­doms? You could run out of money af­ter just 16 years

The Daily Telegraph - Your Money - - FRONT PAGE -

Nearly one in three peo­ple could run out of money in retirement, rob­bing chil­dren of their in­her­i­tance, ac­cord­ing to wor­ry­ing new re­search. Tra­di­tion­ally, most pen­sion­ers bought an an­nu­ity at the point of retirement to guar­an­tee an in­come for life, even af­ter the in­tro­duc­tion of “in­come draw­down”, which al­lowed you to leave your money in­vested and de­cide your own level of with­drawals.

How­ever, that all changed two years ago, when the Govern­ment in­tro­duced the “pen­sion free­dom”, which per­mit­ted pen­sions to be with­drawn at any time and in any amount.

Af­ter the in­tro­duc­tion of the free­doms – which in ef­fect made in­come draw­down the de­fault choice for most pen­sion savers – sales of an­nu­ities plum­meted by more than 90pc, from about 354,000 a year in their hey­day in 2008 to 30,400 for the year to June 2016, ac­cord­ing to the lat­est data from the City reg­u­la­tor.

But now, ad­vis­ers and pen­sion firms are be­com­ing in­creas­ingly con­cerned that the shun­ning of an­nu­ities could be stor­ing up problems for the fu­ture.

Not only may many thou­sands end up hav­ing noth­ing to live on in later life, they may also have to re­sort to raid­ing their other as­sets, such as the fam­ily home, wip­ing out the very in­her­i­tances they were so anx­ious to pro­tect.

Chris Noon, a se­nior part­ner at Hy­mans Robert­son, the pen­sions con­sul­tancy that car­ried out the new re­search, said: “We know the fu­ture is un­cer­tain, so we can’t pre­dict with any cer­tainty whether an an­nu­ity or draw­down is bet­ter, or which in­vest­ment strat­egy will serve pen­sions bet­ter than an­other.

“So we de­cided to look at ev­ery pos­si­ble sce­nario, and ex­am­ined thou­sands and thou­sands of po­ten­tial out­comes.

“There are many good rea­sons why peo­ple should opt for draw­down, or an­other retirement strat­egy. But we wanted to ex­am­ine the best op­tion if your pri­or­ity is to en­sure you do not run out of money dur­ing your life­time.”

Hy­mans an­a­lysed more than 5,000 dif­fer­ent retirement sce­nar­ios and as­sessed how draw­down would per­form com­pared with buy­ing an an­nu­ity us­ing a vast range of dif­fer­ent in­vest­ment out­comes. In an as­ton­ish­ing 30pc of draw­down cases, the money ran out be­fore the in­di­vid­ual died.

“The big­gest sur­prise was that in so many sce­nar­ios the money sim­ply ran out,” Mr Noon said. “This led us to

Scon­clude that, while draw­down may be suit­able for some peo­ple, many may be se­ri­ously un­der­es­ti­mat­ing the risk it can pose.”

Tom McPhail, head of pen­sions pol­icy at Har­g­reaves Lans­down, the in­vest­ment firm, agreed. He said: “We try to en­cour­age clients to guar­an­tee that they can cover their ba­sic out­go­ings via an an­nu­ity and to make sure their spouses will be fi­nan­cially se­cure. Af­ter that, by all means go into a draw­down.

“Oth­er­wise, if you avoid an­nu­ities al­to­gether, there is a sig­nif­i­cant risk that the money will run out and your stan­dard of liv­ing will fall as you try to sur­vive on the state pen­sion. Most will have no choice but to sac­ri­fice in­her­i­tances by tak­ing eq­uity out of their prop­erty.”

An­other con­cern is the sharp drop in the num­ber of com­pa­nies that sell an­nu­ities, with the mar­ket now dom­i­nated by three gi­ants, Canada Life, Le­gal & Gen­eral and Aviva, with Scot­tish Wi­d­ows and Just sell­ing “en­hanced” an­nu­ities, which pay bet­ter rates to those in poor health.

Mr McPhail said: “We could end up with so few com­pa­nies that there sim­ply aren’t enough to pro­vide a com­pet­i­tive mar­ket.”

The Hy­mans re­search con­cluded that, depend­ing on how long you live, some in­vestors would be left with noth­ing in the bank whether they adopted a safe, a medium-risk or a high-risk in­vest­ment strat­egy.

For ex­am­ple, Hy­mans con­sid­ered a 65-year-old man with £100,000 to in­vest. He could buy an an­nu­ity to­day, pay­ing £5,500 an­nu­ally un­til he dies, while the num­ber crunch­ers also ex­am­ined var­i­ous draw­down strate­gies and how they worked out over 35 years.

Mr Noon said: “The draw­down op­tion will re­quire in­vestors to dip into cap­i­tal each year to equal the £5,500 in­come from the an­nu­ity, which will de­plete the fund.”

First, Hy­mans ex­am­ined a very low-risk in­vest­ment strat­egy with around 90pc in cau­tious as­sets such as cash and low-risk bonds and 10pc in higher-risk hold­ings such as shares.

This ap­proach pro­duced at best a lack­lus­tre av­er­age an­nual re­turn of 1.5pc, and at worst just 0.9pc a year.

When all went well, the money ran out af­ter 20 years when the pen­sioner was 85. At worst, the pot emp­tied af­ter 19 years, at 84. Yet six out of 10 men are still alive in their mid-80s, with years of their retirement left to run, ac­cord­ing to Hy­mans, which used longevity data from ClubVita, a spe­cial­ist in the field.

Many pen­sion­ers opt for a “mixed-as­set” in­vest­ment ap­proach, where half of their money is in safe in­vest­ments and the other half in the stock mar­ket. Where this works well for the in­vestor, even al­low­ing for the spills and thrills of stock mar­kets and in­ter­est rates, the av­er­age an­nual growth will be 3.6pc, ac­cord­ing to Hy­mans. But even in this case, the money runs out af­ter 25 years, when the in­di­vid­ual reaches 90.

This may sound en­cour­ag­ing. But of men who in­vest at 65, some 39pc will still be alive at 90. Mr Noon said: “Peo­ple are un­der­es­ti­mat­ing by miles how long they may live.”

How­ever, if the mar­ket crashes early in retirement, dam­age will be in­flicted on your fund from which it will strug­gle to re­cover. In this event the an­nual re­turn might be only 0.5pc and the cash could run out af­ter just 17 years, at 82. Seven out of 10 men are now ex­pected to reach this not-so-grand old age.

Mr McPhail said: “We ad­vise draw­down in­vestors to use other sources of in­come in se­ri­ous mar­ket down­turns. The worst thing peo­ple

An­nu­ity sales have plunged by 90pc as peo­ple adopt the pen­sion free­doms. But new re­search re­veals the risks they are tak­ing, says Teresa Hunter ‘We en­cour­age clients to guar­an­tee they can cover ba­sic out­go­ings via an an­nu­ity’ ‘Peo­ple are un­der­es­ti­mat­ing by miles how long they may live’

can do is con­tinue to take money out of their in­vest­ments af­ter a crash. They de­plete their funds, and when the mar­ket re­cov­ers there is too lit­tle left to ben­e­fit from the up­swing.”

This point is am­pli­fied by look­ing at the fi­nal ex­am­ple Hy­mans gave. Here, the saver adopts the high­risk strat­egy of putting 90pc of their retirement fund into the stock mar­ket in the hope of tur­bocharg­ing the over­all re­turn, with just 10pc in lower-risk de­posits and bonds.

If this strat­egy works well, it could pay off, pro­duc­ing an av­er­age an­nual re­turn of 5.5pc. In this sce­nario, the money will last for 33 years un­til the pen­sioner is 98. But even then, some very el­derly pen­sion­ers could be left fac­ing penury: 7pc of 65-year-old men will reach 99, and 5pc will get a tele­gram from the Queen.

How­ever, high-risk strate­gies can blow up in your face. If mar­kets go against you the out­come could be dis­as­trous. Here the an­nual re­turn av­er­aged over 35 years is a dis­turb­ing “zero” and the money runs out af­ter 16 years – at 81, when seven in 10 men have years of retirement in front of them.

Mr Noon said: “Tim­ing is ev­ery­thing. In this last ex­am­ple there were some great years for the stock mar­ket, but a crash early in retirement wiped out any prospect of sig­nif­i­cant growth in the saver’s over­all pot later. There was too lit­tle left in the fund.”

Price of free­dom? New re­search sug­gests thou­sands of peo­ple may end up hav­ing no money to live on in later life if they use the ‘pen­sion free­doms’

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