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What are the greatest challenges facing those approaching and at retirement today?
There are a number of ongoing challenges for retirees, but at the heart is the question of whether their portfolio will sustain the level of income they need throughout retirement.
This has become more difficult given the current environment of lower interest rates, among other events occurring in the global economy.
Embedded in this is the question of the ideal level of income to take into a drawdown portfolio. One in four people will now live for more than 30 years in retirement. Therefore, people need their income to last longer and the decision of how to structure a retirement portfolio cannot be taken lightly.
In theory, the answer for those who are most worried is to buy an annuity – but few want to give up access to their money.
Are there limitations to current approaches in saving for retirement?
Within a drawdown portfolio, a ‘safe’ and sustainable level of income is about 4% – and there is long-term research that suggests a 50/50 split of equities and bonds invested over the very long term would give an investor this kind of return. This sort of thinking still sits at the heart of most retirement savings plans.
It is possible to take a higher level of income by operating a more dynamic portfolio and incorporating a broader range of assets. But for many, this introduces too many risks. A more aggressive portfolio could provide a better return over the longer term, but it may also be subject to short-term shocks.
Equally, with an average retirement pot of about £30,000, many people cannot afford to take a lot of risk and may be better off with an annuity.
Another option would be a ‘third way’ annuity, where some of the retirement pot remains invested. This approach can give people a guaranteed level of income and some protection in capital. However, the cost of a guarantee can be very high and may significantly erode the amount of income available to clients.
As such, each of these options has its downsides and this is where structured products might offer investors and their advisers an extra option – potentially creating a defined level of income or growth.
What do retirees really need? Where should their priorities lie?
There have been increasing changes not only to the pension system, but also the tax system. Those retirees who have had a narrow range of assets in retirement (buy-to-let, for example) have been vulnerable. Certainly, there is now a growing trend to take income from a wider diversity of sources.
But there are other trends. People are working for longer and many are putting annuity purchases on hold as a result. They may also be looking at a different time horizon for different ‘pots’ of income.
Inevitably, many will have money in old defined benefit schemes and investments built up in ISAs. Some will be invested in growth assets; some for income. This, to some extent, has always been the case.
Investors’ priorities should be to look at their income needs (on a reasonable timeline) and consider how their current holdings can be managed to suit those goals.
Are there any changes you would like to see made to the pension system?
If it were possible to wipe the slate clean, I would give the whole population financial education. In an ideal world, they would know what they have got, what they need to do to move towards their goals and what role a pension would play.
Inevitably, however, safeguards would have to be put in place so people do not fritter away their hard-earned pots. We would need to be sure people understood what was going to happen to their money and the risks inherent in poor decision-making.
Back in the real world, governments, advisers and investment managers have come up with a lot of solutions to give people the right level of information, but none of it seems to work.
Advisers need to be paid for their time, while investors either can’t or won’t pay. They do not understand why they need to sit down and think about it, and they don’t necessarily trust what they hear. They would rather trust their friends. I would really like to see this change over the longer term.
Where can structured products play a role?
Among the current solutions on offer, there are not many that can provide you with a positive return if the market falls.
Certainly, investors may be giving up some upside if markets do very well. But our retirement options give some predictability of returns while retaining the prospect of investment growth.
As such, they can play an important role in improving the risk/return profile of a retirement portfolio.
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