InvestmentsFeb 2 2015

How to tackle the new pensions world

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What have the UK pension freedoms brought, besides a number of unanswered questions? Is this the dawn of an exciting and brave new pensions world or a source of confusion and uncertainty for thousands of individuals?

For the vast majority of investors the answer is very much both – and at the same time as well. Today’s retirees have serious and complex decisions to make about financial futures over which they now have unprecedented control.

The reality is that no matter where you live, outliving your income stream has become a significant risk. If you’re part of a married couple and both of you are 65 years old, there is a 66 per cent chance that one of you lives to be at least 90 years old. Juxtapose this with the expected retirement shortfall and the future starts to look grim.

The top table shows the perceived retirement shortfall for various countries, with the years in retirement that savings are expected to last contrasted with the anticipated years where individuals will have exhausted their income.

No doubt to try to cover some of this gap, many more people are working much later in life. The percentage of people in the UK workforce of more than 65 years old has steadily risen since 2000, with a much sharper increase taking hold in the last decade.

Thinking about retirement planning for most people is like scrutinising a giant flow chart of myriad factors.

There are some over which the individual has total control, such as their rate of saving and spending or the risk they take in their portfolio.

There are other factors over which the person has some degree of control, such as the duration and earnings level of their employment and their own longevity.

Finally, there is a range of factors over which individuals have no control, such as market returns.

Knowing that a wide range of variables can determine financial security in retirement, understanding retirement spending and planning accordingly is critical.

This leads us to two potential models for structuring a sustainable retirement income stream. The first involves a so-called ‘bucket’ method. The individual’s assets are arranged into three buckets according to time horizon, with the short-term portfolio regularly tapped for spending invested in cash and cash alternatives.

The medium-term portfolio can be invested in slightly higher-yielding assets, such as dividend-paying equities.

The third bucket in the portfolio can be reserved for riskier, higher-return strategies or for longer-dated savings instruments. Such a model can certainly help investors to grow wealth over time while maintaining spending to support their lifestyle, but at best it is an inexact rule of thumb.

A second model for structuring a retirement income involves a triangle. Starting from the base of the triangle you move up the spectrum of risk and return.

The bottom and largest portion of the triangle comprises needs – the basic assets that are needed to cover regular expenses. The income sources at the bottom tend to come from an individual’s state or defined contribution pensions, individual savings accounts, short-term bonds or cash savings.

Think of the middle of the triangle as your wants, comprised of your desires to pursue a lifestyle in retirement. Sources of income in the middle of the triangle tend to come from investments in equities or fixed income.

As we reach the top of the triangle, it’s the legacy considerations, where an investor might be considering assets to leave to his or her heirs. This income can be sourced from more high-risk investments or structured in trusts.

Structuring a suitable retirement income stream is different for everyone. However, what is the same for all is the desperate need to start retirement savings earlier and to do it more consistently. The numbers speak for themselves on the power of compounding over time, and they are too significant to ignore.

Saving is important and so is diversification, as a balanced portfolio is better poised to generate returns in all types of market environments.

In the long term, a portfolio that is diversified across equities and bonds can help to dampen volatility, providing a smoother ride for the individual.

No matter how investors ultimately choose to tackle the retirement income question, many will be well served by multi-asset income funds that are accessible and easy to understand. These funds can offer the potential to build and preserve wealth, beat inflation and reduce the risk of outliving one’s assets.

Jasper Berens is head of UK funds at JPMorgan Asset Management

RETIREMENT CONSIDERATIONS: NEEDS, WANTS AND LEGACY

1. Considerations:

What are your basic needs?

What income sources do you have or will you need to create?

How are they taxed?

Potential solutions:

• State pension

• Other pension

• Individual savings accounts

• Collectives/shares

• Bonds

• Cash instruments

2. Considerations:

What are your desires/wants?

How much risk are you willing to take?

Potential solutions:

•l Products

• Equities

• Fixed income

3. Considerations:

What is the time horizon not only of yourself but also of your heirs?

Potential solutions:

• Equities

• House

• Trusts

Source: JPMorgan Asset Management