In 2019, the Institute and Faculty of Actuaries (IFoA) launched its ‘Savings goals for retirement’ research paper. The paper was to act as a sort of ‘guidance’ to indicate how much people might need to save over a full working life in order to achieve a ‘certain standard of living’ in retirement.
This was based on the Pensions and Lifetime Savings Association (PLSA)’s retirement living standards, which set out the expenditure needed to achieve a ‘minimum’, ‘moderate’, or ‘comfortable’ lifestyle in retirement.
The IFoA has recently updated this guidance with a new research paper analysing the risks to ‘staying on track’ to achieve a desired standard of living in retirement.
The risks to staying on track include investment risk, particularly now due to coronavirus and global stock market volatility.
The IFoA says in their paper: “The extent to which defined contributions (DC) will grow over the period to retirement is uncertain, as future investment returns are unknown. In addition, investments can be volatile in the short term – well illustrated by market reaction to Covid-19. These uncertainties present significant challenges to individuals when planning for their retirement.”
Other risks include ‘longevity risk’ – the risk of running out of money in retirement, which is a further challenge for DC savers.
“Purchasing an annuity is the only way to insure against such risk but, as noted above, the cost of doing so can vary over time which makes it hard to plan with any certainty. For savers who take the retirement income by drawdown, there is a risk that they will outlive their savings.
“Notwithstanding the current health crisis, we estimate that a quarter of young people entering the workforce now will live for 30 years or more after retiring at age 68. Coupled with the fluctuations in fund value, for the above example our calculations indicate a 7% (roughly 1 in 14) chance that the fund will be exhausted during retirement, says the IFoA.
What the experts say
Tony Clark, head of retirement marketing, St. James’s Place Wealth Management says there are many risks associated with retirement: “Many people will perhaps focus just on risks associated with investing, but for me, the risks are broader and more human than that, such as:
- Not having a plan – retirement isn’t just a series of financial decisions, it’s a life decision as well. What do you want your life to be like in older age? Will the reality match up? Having a well thought out, flexible plan for achieving the retirement you want, will help bring your dreams to life. And make sure you write it down.
- Underestimating how long you will live for – The 100-year life is fast becoming a reality, and that necessitates thinking hard on how much of your life you want to spend in retirement.
- Making assumptions – It’s an easy trap to fall into as we’re all human. For example, thinking the state pension will be enough to live on, or you’ll downsize your property when the time comes. Being informed and realistic about retirement is half the battle.
Clark also says it is difficult to mitigate risk entirely when saving for retirement: “Keep in mind that you may need to alter when you retire, or how much you save over time. Also, saving regularly and starting early are a good way to give yourself a cushion against certain risks such as market volatility.
“Diversifying your investments is also a good idea, which should extend to using multiple assets and sources of income in retirement. A pension is important, but don’t forget you could also use ISAs, perhaps your property, savings, and even earnings as well.”
Toby Band and Ben Barratt, private wealth directors at the Arlo Group says the Covid-19 pandemic has derailed many savers’ retirement plans: “The economic fallout from the crisis has resulted in mass redundancies and sustained unemployment for those job-hunting. As a result, pension contributions will have halted, while some will have been forced into an early retirement if they were in the twilight of their career and felt the prospects of them finding another job in the current climate was low.
“Additionally, pension freedoms – that allow people aged 55 or over to withdraw up to 25% of their pension tax-free – pose a significant risk to savers’ long-term retirement plans. If someone takes too much too early to support their lifestyle without a normal or expected level of employment income, this could mean their standard of living in later life suffers as a result.
“There is also a derailment risk to savers on defined-benefit (DB) schemes, particularly if their company faces insolvency and falls into the Pension Protection Fund. While this will provide some compensation, the figure may be far lower than what was expected through the DB scheme. This is particularly true in the current climate, with gilt yields being driven down by quantitative easing and lower interest rates.
“Pension funds often have significant holdings in UK Gilts, so low yields will make it harder to meet the income payments for their scheme members. This could ultimately lead to the burden of DB schemes becoming too expensive to the employer and individuals seeing their benefits reduced.
“For investors coming close to retirement, the risk to sequencing will remain high as long as the market stays volatile. Negative returns when an investor is disposing of accumulated assets is much more damaging than in the accumulation stage, as investors aren’t adding new capital to purchase assets at discounted prices, which would go a long way to offsetting losses in the long terms.
“As a result, individuals being forced to retire early and take their pension pots are much more likely to be adversely affected by the impact of volatile markets, particularly if their portfolio isn’t properly aligned to their time frame for investment and income requirements. If the pension has been left in autopilot for a prolonged period, the funds may no longer be appropriate and people that are forced to retire early may be leaving themselves exposed some nasty surprises if the market remains volatile.”