Pension freedoms changed how consumers interact with their pensions but what does this mean for older consumers when it comes to making choices?
In 2017, the Financial Conduct Authority (FCA) commissioned research agency the Big Window to conduct an extensive review into the Ageing Mind, as part of its Ageing Population project.
The purpose of the review was “to provide a good working overview of the entire spectrum of cognitive factors that could affect the way in which older consumers engage with financial services”.
From a retirement perspective, the good news is that financial decision making, in general, reaches optimal performance in the mid-50s. Less good however is that from then on it is in steady decline until the late 60s/early 70s when the decline then becomes more marked.
Quoting directly from the review: “This is concerning given that an older consumer is likely to be dealing with more complex financial products (e.g. equity release, investments, annuities etc.) and the amounts of money involved may be significant, as assets tend to increase over the course of a lifetime. The older consumer is also less likely to be able to address the consequences of any poor financial decisions at this life stage.”
Ongoing challenge
Against the backdrop of pension freedoms (meaning that customers have to actively make choices about their retirement funds), there is now an ongoing need for the customer to make decisions around more complex or even new product terms as they age (and in many cases become more vulnerable).
For those customers in income drawdown, making decisions around investment risk and sustainable income needs as they enter their 70s, even with the help of an adviser, may prove to be challenging.
The FCA’s study identified what they have called a ‘confidence-reality gap’ where customers may not acknowledge their declining ability or are employing coping strategies that disguise it. In short, your client may come across as more confident and capable than they truly are – which makes spotting their vulnerability yet more challenging.
In my last article, I talked about how annuities remain relevant for two different groups of customers and that there is an emerging third group.
The first two groups of customers were those who value certainty and simplicity over absolute return and those who are willing to take some risk but want to know their essential spending is always going to be covered.
The third group are customers who, as they age, are starting to recognise that while drawdown has given them flexibility of income in the early, and possibly ‘semi’, retirement years, they no longer have the cognitive capacity or drive to monitor their investment or the appetite to weather stock market fluctuations.
They are now looking for a more regular and predictable income, having previously been living off a mixture of part-time working, tax-free cash, savings and ad hoc draws as they’ve been transitioning towards full retirement.
As this post-pension freedoms cohort of customers grows and matures, we expect that this will become a growth area for annuities, with some of these customers seeing greater value from partially or fully locking into a guaranteed income at age 70+, particularly if they have impaired health.
By 2025, those aged 60 and over and who were among the first cohort of retirees to enjoy pension freedoms will be moving into their 70s – an estimated 1m people.
Additionally, by this point many retirees will have a more stable spending pattern – having moved from the early and more active ‘go go’ phase where spending will have been higher and more erratic (as they make the most of increased time to pursue hobbies or travelling, for example), and into the less active ‘go slower’ phase – leading to a reduced need for flexibility and in many cases reduced spending needs overall. They may be in a position where they can fully or partially annuitise and comfortably maintain their lifestyle.
It is worth noting that those retirees reaching their 70s could expect to live for a further 20 years, according to ONS statistics.
Critical point
This brings us to the critical point around income. Just how compelling are rates for customers in their early to mid-70s?
A typical annuity for someone aged 75 in good health is currently around 6.8%, increasing to c. 7.2% for those customers with moderate health issues. This compares very favourably with a sustainable withdrawal rate from lower-risk funds of around 3%.
And if value protection is chosen at 100%, this still comes in at an attractive 5.4% for those with good health and 5.5% for those with moderate health issues.
For those who haven’t yet read Ageing Mind review, here is a link. For anyone advising clients at and into retirement, it is an essential read.
We all recognise that ageing and risk of vulnerability often go hand in hand. We are now much clearer about the nature of vulnerabilities associated with ageing.
Anticipating this ahead of time is where advisers can add real value. Consideration of how annuities can help to mitigate the impact of ageing is going to be vital.
Greg Neilson is managing director of retirement at Aviva