Mind the Retirement Income Gap
Perhaps the single biggest issue facing the hundreds of thousands of people who retire each year is how wide the gap will be between their desired and actual retirement income and the impact that this will have on their standard of living.
Quite often this gap is due to a lack of foresight, and planning, but life events such as divorce, separation, redundancy, and ill-health can also unexpectedly de-rail retirement plans.
Many people find it difficult to picture what retirement might look like and planning for something that is hard to imagine can be challenging, to say the least. Looking forward to what life might be like, even a few months ahead, can be tricky, let alone what it might be like in the decades to come.
What is true across the board is that a fundamental underlying cause of The Gap is a wholesale lack of engagement with retirement planning and an all-too-common mindset of ‘it can wait until tomorrow’ and ‘out of sight is out of mind’.
It is expected that, as auto-enrolment pension savings build, engagement in retirement planning will improve and the long-awaited pensions dashboard that gives the visibility to all pension savings under one roof, will also help.
However, these initiatives will not be help those who have recently retired or are considering transitioning into retirement over the course of the next twelve months.
Some more detail on the causes of The Gap
1. Improvements in longevity – with improved health, life expectancy at age 65 is now 18 plus years1. The age at which the state pension commences may continue to be put back and the state pension alone may not be relied upon to provide a comfortable retirement
2. Employer-sponsored final salary schemes, providing guaranteed retirement income, are in decline for most private businesses. Today’s retirees may well still retain some DB provision but, unless they have spent their entire working life with the same employer or are long-serving employees from the public sector, these are unlikely to deliver benefits that are generous enough to provide for a comfortable retirement.
3. Defined contribution savings for those coming into retirement continue to be inadequate, with the average accumulated savings for those between age 55 and retirement standing at just £37,6002. Many people may have saved more than this average amount, but most pension savings will still be insufficient to support a moderate or comfortable retirement (see below).
4. Recent strains on finances created by inflation, rising energy bills, increasing interest rates and the consequent cost of living crisis will persist throughout 2023 and possibly beyond. This potentially means that less money may be committed to pension saving as other more immediate and pressing needs are prioritised.
5. The under-utilisation of capital that is available in mortgage-free housing, more on this later.
The Pension and Lifetime Savings Association (PLSA) estimated in 20213 that a moderate standard of living in retirement would cost £34,000 a year for a couple, rising to around £54,500 for a comfortable retirement. This outlook will have worsened significantly over the course of 2022 due to the uncertain political and economic situation.
The current environment is putting strain on pension income drawdown plans and those who are reliant on this regular income, as the capital funding it may be falling in value. Clearly, the more money that is withdrawn from a pension pot that’s declining in value, the harder, over time, it will be to make these losses back, if it’s possible at all.
What’s more, with inflation at over 9% in December 2022, more income will be required from a dwindling pot just to ‘stay still’ in terms of what needs to be spent.
Potential solutions to The Gap
As a comfortable income could clearly be out of reach for many, what can be done to address the Retirement Income Gap and what approaches might offer at least some mitigation for the expected shortfalls?
Unfortunately, potential solutions to the income gap in a high inflation, higher interest rate environment are not easy to come by and aren’t always particularly palatable.
But there are options that can be considered, some answers lie in work and retirement choices and others in turning to neglected retirement products, which are making a return to favour.
1. Delay retirement: working longer full time or part time will keep valuable benefits intact such as pension contributions (which should be maximised) and, of course, a salary. Any accumulated pension won’t need to be accessed. Delaying retirement is unpalatable for some, but others find that they lose purpose in full retirement – so delaying this and allowing extra time to plan for a full retirement, in every sense, may well be sensible.
2. ‘Un-retiring’ – is starting to emerge as a post-pandemic phenomenon. There is emerging evidence4 that many who intended to retire early are now considering re-entering the workforce as the cost-of-living crisis bites. If an ‘un-retired’ person’s pension is uncrystallised, then the full annual allowance will be available to them to save. There will also be those, as mentioned above, who miss the purpose of work and want to return to paid employment. This could be to a completely different vocation than before they stopped work, such as taking a part time job or even monetising a hobby or interest as a small business.
3. Reduce risk and volatility in existing pension saving. Moving into lower risk investments to preserve capital when retirement is closer can work to mitigate any at-retirement shocks, particularly if adequate funds have already been accumulated.
4. One action can, of course, be to accept that the standard of living in retirement will be lower than is ideally desired and that cloth will need to be cut accordingly.
However, there are product solutions that will work to bridge the retirement income gap, even in the current troubled environment and not all of them involve a return to the workforce or accepting additional investment risk to make up savings that may have been lost.
Guaranteed Income from a Lifetime Annuity
One silver lining of a higher interest rate environment is that annuity yields are the highest they have been in quite a while. Purchasing an annuity doesn’t have to be a ‘once and done’ decision and can be a powerful tool as part of a holistic retirement plan, balancing exposure to growth assets such as bonds and equities with a secure income for life.
The guarantee of an annuity, alongside the state pension, can go a long way towards providing an income that can cover essential costs in retirement. It’s also worth remembering that with age annuity yields will tend to rise, particularly for clients who they have medical or lifestyle conditions that qualify them for an enhanced annuity. So, moving more of pension savings into secure income as age increases is always worthy of active consideration.
An example:
A £100,000 pension pot for a 65-year-old male could buy a non-medically underwritten annuity of £6,253 per year with Aviva. Add in some moderate health and lifestyle conditions, such as high blood pressure and consuming 40 units of alcohol per week and, for a medically underwritten enhanced annuity, this rises to £7,035 per annum. It’s always worth remembering to explore health and lifestyle conditions with the mantra that: ‘they will qualify unless proven otherwise’.
The example above hasn’t included any of the product features available via a lifetime annuity such as spouses’ pension, indexation, guaranteed payment periods or value protection. Adding these in will bring the overall income down but will provide additional benefits which may be valuable to individual clients.
Equity Release
Historic long-term gains in house prices could be put to good use in retirement and, in the absence of adequate pension saving, equity release from the family home is a powerful candidate for bridging the retirement income gap.
The over 65s have an estimated median of £240,000 of free equity in their homes5 which, for most, will dwarf their accumulated pension savings. Freeing up this money to provide for a more comfortable retirement merits much wider consideration than it currently receives.
We have an extensive article on considering the home as part of the solution to The Retirement Income Gap, which is available here.
Conclusion
The Retirement Income Gap will be with us long into the future, perhaps forever. However, with the right planning and advice, there are a range of ways to bridge the gap so it’s not as daunting and insurmountable as it may first appear to be.
1ONS: Life Expectancy at Birth and at Age 65 for the UK and Local Areas in Scotland.
2ONS: Saving for retirement in Great Britain: April 2018 to March 2020, June 2022.
Contains public sector information licensed under the Open Government Licence 3.0.
3Pension and Lifetime Savings Association, Retirement living standards study
4ONS: Returning to the workplace, August 2022.
5The Lang Cat, House Rules, June 2022.