Guide to retirement income and planning
Post-pension freedoms clients have more choice and flexibility when it comes to their retirement income needs
Ask clients who are preparing to retire whether they would like to maintain the same standard of living in retirement as they had while working, and I'm sure most will answer, ‘yes’.
But accumulating enough savings to meet those expectations is challenging.
Before the pension freedoms were introduced, there was little in the way of choice - those at retirement simply bought an annuity, which paid a regular income for them to live off.
Drawdown has certainly allowed some clients to enjoy more flexibility in their retirement income but it does more financial planning, which is where advisers come in.
Kate Smith, head of pensions at Aegon, says: "Retirement income is what someone will need to replace their current income when they stop working.
"Retirement income needs will depend on the type of life people would like to lead once they give up work. The amount needed will depend on people’s lifestyle, aspirations, health and life stage."
As Fiona Tait, technical director at Intelligent Pensions, observes, it is possible to save for retirement using a range of savings vehicles, including Isas, stocks and shares, and in some cases, property. Although she acknowledges the most obvious route is a company or personal pension.
But with clients living longer once they have retired, it is likely income needs will fluctuate throughout those later years - potentially peaking when clients require adult social care towards the end of their life.
Read on to find out more about retirement income and planning, including how to accumulate retirement savings, the options post-pension freedoms and how to deal with vulnerable clients.
What are retirement income needs?
Gone are the days when most individuals retire with handsome defined benefit pension pots knowing exactly how much they can spend in every phase of retirement.
Retirement needs today are more complicated and vary through different stages of the retiree’s later life.
Billy Burrows, founder of William Burrows Annuities, says: “Since pension freedoms [were introduced in 2015] many people have confused cash with income, which has resulted in many people moving away from regular income streams – such as defined benefit pensions or annuities – to a more ad hoc approach by taking a combination of cash and income withdrawals.”
But why does the amount of money that pensioners need vary at different times?
A number of experts say retirement income needs follow a “U-shaped” path, and suggest advisers and clients should plan based on this path.
Kate Smith, head of pensions at Aegon, explains: “Generally, income needs in retirement form a ‘U shape’.
“In the early years of retirement, say in their 60s, spending is high as people are likely to spend money on things like travel, home improvements, hobbies and memorable time with family.”
She continues: “As age sets in and health starts to deteriorate, people start to downsize their lives a little, living more simply, staying closer to home and maybe caring for their partner. Spending flattens out.”
According to Ms Smith, spending in retirement then spikes again as health deteriorates and care costs need to be met.
For the majority of retirees, the U-shape simply doesn’t work.
Mr Burrows highlights the importance of advisers creating a proper cash flow forecast, although he warns clients often do not recognise the importance of planning ahead.
But Andrew Tully, pensions technical director at Canada Life, dismisses the U-shape analogy.
“As an industry we often quote the classic U-shape retirement as a guide to income needs through retirement.
“The reality is, of course, no-one can accurately predict the pattern of expenditure, neither clients nor their advisers. For the majority of retirees, the U-shape simply doesn’t work,” Mr Tully asserts.
Many experts say retirement products need to be more flexible to meet changing needs throughout retirement.
Mr Tully notes: “Financial plans require a degree of flexibility, with the need to vary income through the different stages of retirement.”
He adds: “Ideally retirees need a plan which delivers a fixed income stream to meet essential and important expenses, with a degree of flexibility to accommodate changing income needs at the different stages of later life.”
He also says retirement income plans should offer lump sums for one-off costs, such as repairing a boiler.
“This leads to a conversation around combining an annuity and drawdown to deliver the best of both worlds,” Mr Tully suggests.
Russell Warwick, managing director of Primetime Retirement, says not all consumers will follow this same pattern.
“As such, it is necessary to balance forward planning with flexibility when considering retirement options, as the consumer’s individual circumstances are likely to develop over time,” he confirms.
Social care conundrum
Experts are divided on the importance of social care in the later years of life.
Mr Tully says only 20 per cent of men aged over 65 will require residential care, meaning their income needs will “decline in real terms” as they go through retirement.
But Sir Steve Webb, director of policy at Royal London, disagrees.
“As we live longer, more and more of us run the risk of facing huge care costs in later life. A nursing home in the UK can cost £1,000 or more, and a typical stay can hugely dent someone’s pension pot,” he says.
In late retirement we might typically see the need for greater income again, to help pay for possible care costs.
Sir Steve Webb estimates that around 20,000 people a year have to sell their home to pay for residential or nursing care in later life.
Mr Warwick acknowledges: “In early retirement a consumer is likely to still be very active and looking to enjoy the benefits of retirement, such as going on holiday, meaning they require a high level of income.
“These income requirements may then dip as the consumer reaches mid-retirement and they become less active.”
He continues: “However, in late retirement we might typically see the need for greater income again, to help pay for possible care costs.”
While funding healthcare is an important retirement need, individuals also require a varied income to not only prepare for unprecedented shocks, but also to replicate their pre-retirement lifestyle as closely as possible.
Essential expenditure is likely to remain relatively constant year-to-year, subject to inflationary pressures, according to Mr Tully.
Mr Warwick suggests: “For most consumers the initial focus will be ensuring they have a basic level of income to help meet their basic living ‘standard’ requirements in retirement.”
He adds: “Including the term ‘standard’ is important, since an individual’s beliefs about their basic income in retirement won’t simply be a combination of adding up utility costs and other outgoings, but will also be related to the standard of living they are used to in pre-retirement.”
Saloni Sardana is a features writer at FTAdviser and Financial Adviser
What are the different ways to accumulate savings for retirement?
How many people can actually afford the same luxuries they enjoyed pre-retirement once they retire?
Many people have expectations about how their lifestyle in retirement will look but some clients may underestimate just how much they need to have saved for retirement in order to live how they wish.
The good news is that there are numerous ways people can save up for retirement to make it more likely they are able to match their standard of living.
Experts say pensions are still the best way to accumulate savings because of pensions tax relief.
Andrew Tully, pensions technical director at Canada Life, says: “Pensions continue to dominate the retirement savings market for very good reasons.
“The tax relief available through pension savings, combined with the pension freedoms offering flexibility when clients look to take benefits, is a winning combination.”
He points out: “As a new generation of pension savers is supported on the retirement journey through auto-enrolment, this popularity is set to continue – 73 per cent of UK employees had an active workplace scheme in 2017, up from less than 47 per cent in 2012.”
Kate Smith, head of pensions at Aegon, says qualifying for a state pension is one way to accumulate retirement savings.
“The state pension will form the foundation for many people’s retirement income needs, so it’s important people check that they have a complete National Insurance record so they will get their full state pension,” she notes.
Maximising savings into Isas will suit people who might need access to their savings ahead of reaching retirement.
The Department for Work & Pensions states an individual must pay a minimum of 30 years of NI contributions in the UK to be eligible for a full state pension.
Those individuals who have clocked up fewer than 30 qualifying years, will receive a basic state pension of less than £125.95 a week.
All the experts stress while pensions constitute a major source of retirement savings, this needs be coupled with other savings vehicles, such as Isas.
Russell Warwick, managing director of Primetime Retirement, says: “Pensions still remain the most effective method for most consumers to accumulate savings for retirement.
“However, increasingly, they are combining this with other forms of investment and savings. For example, Isas are a broadly comparable method of saving with the added benefit of having flexibility over how and when to use the accumulated funds.”
Mr Tully believes Isas will remain a popular vehicle for shorter term savings goals, or for people with no employer provision, such as the self-employed.
“Cash Isas and stocks and shares Isas might be considered as an additional means to save for retirement tax efficiently,” Ms Smith acknowledges.
“Maximising savings into Isas will suit people who might need access to their savings ahead of reaching retirement.”
She adds: “Although not as tax-efficient as pensions, Isas can be a useful bridge in transitioning into retirement, as payments, unlike pension income, aren’t taxable.”
Pensions are specifically designed for long-term savings and receive very favourable tax treatment.
The Lifetime Isa is a recent addition to the Isa range, having been introduced in 2017.
“It can be opened by savers aged between 18 and 40 and used to save for a first home or save for later life,” explains Ms Smith.
An individual can put up to £4,000 a year into a Lisa, up until the age of 50. This counts towards the annual Isa allowance of £20,000 a year. The government will add a 25 per cent bonus to savings, up to a maximum of £1,000 a year.
“We are still waiting to see if Lisas take off, but for those meeting the criteria and already exhausting other retirement saving options, a Lisa might be an option to consider,” says Ms Smith.
In July 2018, a group of MPs called for the Lisa to be abolished on the grounds that they may discourage people from saving into a workplace pension, and therefore miss out on employer contributions.
But Mr Warwick suggests there is scope for Lisas to become another useful tool for retirement saving.
He notes: "While Lifetime Isas are yet to be widely used by consumers as a retirement savings vehicle, regulations around retirement planning are set to develop so there is no doubt that these products will become a more significant component of long-term retirement planning."
Property versus pensions
Property is often thought to be another useful way to set aside some funding for retirement.
Ms Smith explains: “For some people property might form part of their retirement savings portfolio.
“This could be downsizing their own home to release capital, or taking an income in retirement from a buy-to-let property.”
While Ms Tait points out investing in property can be used as an alternative or complementary savings vehicle, she cautions “it could take some time to access these savings even in favourable markets”.
“It is possible to save for retirement using a number of different savings vehicles such as Isas, stocks and shares, or property, but the most obvious route is to use a personal or company pension plan," she says.
“Pensions are specifically designed for long-term savings and receive very favourable tax treatment, both when making contributions and while the fund remains invested.”
Saloni Sardana is a features writer at FTAdviser and Financial Adviser
Retirement income options post-pension freedoms
George Osborne’s plan to cut savers some slack in their retirement income options has endured a fair amount of derision in the past three years.
The former chancellor’s pension freedoms, introduced in April 2015, were chided for causing confusion among consumers, discouraging prudence among retirees and inadvertently leading pensioners to outlive their savings.
Critics will continue, no doubt, but the picture of options now open to individuals and how they’re using this flexibility, is a little more nuanced.
More than one million people aged over 55 have accessed defined contribution schemes since the changes, and a substantial amount of those have deployed the cash in ways that suggest they’ve not been trigger-happy spending. Moreover, many are using the sums to spur their income.
Figures from the Financial Conduct Authority (FCA), published in its Retirement Outcomes Review Final Report in June 2018, show that, between April 2015 and September 2017, more than 1.5 million defined contribution pension pots were accessed.
More than half (55 per cent) of all the pots accessed were fully withdrawn. Nearly all individuals (94 per cent) who withdrew fully had other sources of retirement income. But most tellingly, 52 per cent of the fully withdrawn pots were transferred into other savings or investments.
Pension freedoms opened up a spectrum of income options and with it we saw a significant shift.
So, many savers are apparently being responsible with their freedom, but how many of them are bewildered by more choices? This is unknown.
What is known, is that greater flexibility has yielded behavioural change.
Russell Warwick, managing director of Primetime Retirement, which provides fixed-term retirement plans, explains: “Pension freedoms opened up a spectrum of income options and with it we saw a significant shift.
“The use of income drawdown grew significantly, as consumers’ thinking moved towards purchasing options with greater flexibility.”
Mr Warwick believes that in some cases, this was driven by consumers ceasing to think about pension funds as simply a retirement income proposition.
Instead, they’re now considering things like income and inheritance tax, and using their whole asset portfolio most efficiently for their income.
Mr Warwick adds: “There is undoubtedly a segment of consumers seeking to utilise pension savings at an earlier age.
“In some cases, these consumers want to use funds to help bridge a gap in their retirement income, before they reach state pension age. Others want to have an enhanced standard of living in early retirement, at the expense of income in later retirement.”
While many consumers may opt for a better quality of life earlier, they’ll have to consider tax thresholds, warns Kate Smith, head of pensions at Aegon.
She boils down retirees’ main income options to three - cash in their pension from 55, income drawdown and an annuity.
She says: “People can still take up to 25 per cent of their pension pot as a tax-free lump sum. This applies if you choose income drawdown or an annuity or decide to cash in your pension.”
Ms Smith explains it comes down to the fact “the more people have saved, the greater their retirement income options”.
If people have multiple pots, she adds, they can decide to cash in small pots, go into income drawdown for larger amounts, and then later buy guaranteed income via an annuity.
But Ms Smith warns: “As part of their retirement income strategy people should avoid paying more tax than necessary, for example by cashing in large amounts of their pension which causes their taxable income to hit a higher tax bracket.
“To maximise their savings, people should prioritise how they start to access them, so they don’t get stung by tax.”
Fiona Tait, technical director at Intelligent Pensions, explains further the benefits that can and can’t be taken, depending on how savers access their pots.
She says consumers should be aware they can withdraw money fully as a single lump sum, as income via a flexi-access drawdown (FAD), or annuity purchase, or by using a combination of both.
“Benefits can also be drawn via a series of separate encashments across a number of years, and it is possible to select a different retirement option each time,” she suggests.
Drawdown has increased in popularity at the expense of annuities, as people are drawn to flexibility at the expense of security.
Lump sum withdrawals are known as uncrystallised funds pension lump sums (UFPLS), Ms Tait explains, and are each made up of 25 per cent tax-free cash and 75 per cent income.
Under FAD the full 25 per cent tax-free cash is taken upfront and the remainder is left invested, to be withdrawn over time as income.
Benefits under a final salary or defined benefit arrangement cannot be taken using UFPLS or FAD. The only way to access these options is by transferring to a defined contribution arrangement at or near to retirement.
A consequence of the pension freedoms was a migration away from annuities to defined contribution schemes.
The FCA’s final report shows that, since April 2015, twice as many pots have been used for drawdown than to buy an annuity.
Andrew Tully, pensions technical director at Canada Life, observes: “Drawdown has increased in popularity at the expense of annuities, as people are drawn to flexibility at the expense of security.
“Many pundits thought the pension freedoms would signal the end of the annuity, but with longer guarantees now available, advisers and clients are using the product in new ways.”
Perhaps there’s another industry debate to be had, around whether the freedoms will spark a flourish of innovation, as providers try to offer security and flexibility in equal measure.
Marcel Le Gouais is a freelance journalist
How should advisers deal with vulnerable clients?
It's easy to fall into a trap, when describing retirement planning for an ageing population, of inadvertently lumping those over a certain age into a homogeneous 'vulnerable' group.
Generalised terms for elderly clients, as well as approaches to them, risk stereotyping, patronising and even offending many who may well be lucid in their thinking and choices in retirement.
Nevertheless, responsible advisers need the know-how to support a segment of customers within their elderly client base who are in vulnerable circumstances. As retirement planning extends further into old age, this necessity is becoming more evident.
The question for advisers is how to approach situations with a sufficient balance of understanding, respect and subtlety, so as not to fall into the trap.
Learning to adapt
Practical help and information has been published by the regulator and free debt advice providers, but the wisdom of fellow IFAs can help too.
Kate Smith, head of pensions at Aegon, says: “The number of people aged over 80 is only expected to increase and with more people working longer, advisers will find the demographic of their clients shifting to reflect this."
The Financial Conduct Authority (FCA) noted this demographic growth in its occasional paper, Ageing Population and Financial Services, published in September 2017. It said those aged 75 years and over represent the fastest-growing segment of the UK population.
So advisers will need to adapt to elderly clients' needs, and identify if and when they become vulnerable.
Advisers need to take care when dealing with vulnerable clients that nobody is exercising undue pressure on them.
Ms Smith adds: "Understanding and capturing the particular vulnerabilities each client has – be it reduced hearing, sight or mobility, memory, ability to understand complex issues or something more serious like dementia – will help advisers support clients in the most sensitive way."
Policies should exist, Ms Smith says, that involve encouraging clients to talk about vulnerabilities and their changing circumstances - though that's no easy task.
Russell Warwick, managing director of Primetime Retirement, which provides fixed-term retirement plans, says it is important not to assume that advancing age is a factor for everyone in influencing vulnerability.
"The factors that affect vulnerability are so broad that the majority of consumers, at some point in their life, will potentially fall into the definition of being vulnerable," he explains.
The financial services sector has ramped up the focus on vulnerability in recent years, with retail banks focusing on identification and support for customers in various vulnerable conditions, including addiction, mental health, terminal illnesses and gambling problems.
Partnerships with organisations such as Macmillan Cancer Support and the Samaritans have become vital.
This focus has precipitated the creation of guidance tools to help providers.
In one example, debt advice charity the Money Advice Trust published in March 2018 a guidance document – Lending and Vulnerability: An Introductory Guide to Mental Capacity.
The report was authored by the trust's vulnerability lead Chris Fitch, and built on 2017 research led by his team at the University of Bristol’s Personal Finance Research Centre.
Although aimed at lenders, the report contains practical tips for conversations with customers which are transferable to providing advice. Such tools could help advisers identify and support customers with a mental capacity limitation.
Another report authored in 2017 by Mr Fitch – Vulnerability: A Guide for Lending – also offers a range of practical information, some of which could be applicable to retirement planning advice.
Just one example is a protocol, BRUCE, designed to help staff look for clues in a customer’s speech which may indicate a problem with remembering, understanding, communicating or evaluating the options being discussed.
Along with guidance tools and training available through the Money Advice Trust, the FCA also offers practical snippets in its Ageing Population and Financial Services occasional paper.
The paper sets out ideas for service design, customer support and strategy reviews, which can be adapted for different business models.
The Personal Investment Management & Financial Advice Association (Pimfa) also runs seminars on this issue and in September 2018, published a report, Vulnerable Customers: A Guide, which offers specific procedural guidance.
It’s good practice to discuss setting up a lasting PoA relatively early in retirement, even if there are no obvious signs of impairment.
Aside from utilising training tools, Billy Burrows, founder of William Burrows Annuities, says advisers need to "go the extra mile and ensure clients understand the options and risks", emphasising that IFAs need to be aware of conditions and involve clients’ family members if possible.
The flipside to this, as Mr Burrows points out, is that charities helping the elderly have encountered cases where family or friends have an eye on the cash from someone's pension pot, following the introduction of pension freedoms.
He notes: "Advisers need to take care when dealing with vulnerable clients that nobody is exercising undue pressure on them."
There are, however, occasions where a close family member is the best option.
Fiona Tait, technical director at Intelligent Pensions, believes advisers should consider different ways of interacting with clients who cannot make rational decisions about retirement options, due to an illness.
She adds: "One option is to remove decisions from the client, either by purchasing an annuity which will run for life without ongoing intervention, or by transferring the decision-making to a trusted individual using a power of attorney (PoA).
“It’s good practice to discuss setting up a lasting PoA relatively early in retirement, even if there are no obvious signs of impairment, because it’s possible to set one up only while the donor still has mental capacity. Once this is lost, it’s too late.”
More generally, there are signs that industry thinking is shifting, according to Mr Warwick.
Rather than simply trying to spot vulnerability and providing treatment around a small group of consumers, he thinks providers are now "thinking about developing material and product offerings which address vulnerability from the start of the retirement planning process".
Marcel Le Gouais is a freelance journalist