What do people really want from their retirement income?

In “the old days”, most would-be retirees had a plan that involved picking a retirement age — or having it picked for them by their employer — and then buying an annuity with all the pension savings they had accumulated up to that point. 

The pension freedoms changed all that. The decline of the availability of defined benefit schemes in favour of less-generous defined contribution pensions also had a big impact. In addition, longevity changes contributed to a rethink as typical life expectancy increased, for men at least, by more than five years for a 65-year-old in 1980, when compared with a 65-year-old in 2020.

So, the average life expectancy for men aged 65 in 2020 was 83.5 years (up from 78.4 years in 1980), and for women it was 86 years (up from 81.8 years). Furthermore, the pandemic years appear to have precipitated earlier retirement for some as average retirement ages fell marginally for both men and women between 2020 and 2021, according to data from the Office for National Statistics. 

Contribution holidays

These changes opened up the “opportunity” for greater disruption in retirement saving habits, with many individuals taking pension contribution holidays, for example.

They also raised the spectre of more of us under-saving for retirement, given the fact that most will be of retirement age or older — as defined by the state pension age or above — for longer than in the past. Hence the baby boomer generation retirees today will need to have saved more than the previous generation. 

The baby boomer generation retirees today will need to have saved more than the previous generation

However, it is not just about persuading would-be retirees to boost their contributions on the run-up to retirement, but also working out how and when to decumulate and how to make those contributions stretch further.

Here, we look at some of the options for individuals facing retirement:

Tax-free cash lump sum

For many, having tax-free cash is a great way of kicking off retirement in style. Taking a quarter of an entire pension pot tax-free upfront might comfortably pay for that new car, the world cruise, or a longed-for home extension. It seems a good way to mark such a momentous life event as retirement. 

However, would it be better served by taking the TFC in increments as part of a drip feed income drawdown plan? Independent financial advisers increasingly use online tools built into their advice platforms to assess the likelihood of running out of money in differing decumulation scenarios, and could use this intelligence to advise on decumulating a slice of TFC as part of regular withdrawals from a client’s income drawdown plan. It certainly looks more tax-efficient. 

Does the individual need to support their partner in retirement?: If the partner has independent retirement income sources, then there may be no need to consider their income needs during their retirement years together. It might be sensible for advisers to consider both saving pots and retirement plans to work out if there are any income gaps emerging.

Not all partners want to retire simultaneously. There may be age differences or career trajectories at play. Considering the partner is particularly important if a person is looking to buy an annuity – clients are often surprised at how little extra it costs to add a spouse benefit of maybe 50 per cent pension continuing after their death. 

Any dependants to support?

Do they have other dependants that they want to support through their retirement? Demographic shifts as they are, it is more likely than ever that retirees will be supporting children and grandchildren with education and/or housing costs out of their retirement income.

Logically, this trend must have an impact on retirement income needs. However, does it also mean a bigger focus on what the next generations will inherit from the retiree? If they want them to be assured of benefiting from any remaining pension savings, they will need to make sure they keep as much as possible in their DC pension.

It is more likely than ever that retirees will be supporting children and grandchildren with education and/or housing costs out of their retirement income

The individual may also want to avoid the traditional glide path away from riskier assets if they are trying to optimise what the next generations inherit after they die, because planning to leave an inheritance at the end of retired life is a long-term investment horizon. 

Do they need to increase their retirement income each year? We have written before about the need to bear in mind different income streams as part of income drawdown planning. For example, it is worth building in dates for receipt of the retiree and their partner’s state pension entitlement if they have retired before the individual's respective state pension age. They can then schedule a reduction in income drawdown amounts as the state pension payments start coming in. 

Keeping up with inflation

By the same token, is the retiree determined that their retirement income needs to rise to keep pace with inflation? If so, over the past couple of years of retirement they will have needed to increase their retirement income by close to 10 per cent each year. However, they might prefer to leave it to their own and their partner’s triple locked state pension payouts to counteract inflation rises. 

If that is the case, then there are other decumulation options including level-term annuities and, in the future, decumulation collective defined contribution pension schemes, which will target but not guarantee increases in line with inflation and should assure higher investment growth.

Another option for keeping up with inflation in retirement is buying inflation-linked annuities or assets such as “linkers”, which ensure both the annual interest payments and final capital repayment rise in line with inflation. 

When thinking about whether an individual needs to prepare to increase retirement income year on year, it is worth considering the Institute of Fiscal Studies’ research, which shows that pensioner expenditure increases faster than inflation, at close to the consumer price index plus 1 per cent until age 80, and then continues to increase from then on, but at a slightly slower rate of around 1 per cent a year until age 88.

Access to liquidity

Do they have access to liquidity in their other savings? The essence of retirement is that it is a period of running down savings. That means selling them, which means finding a willing buyer. Markets have shown recently that we cannot simply label assets as “liquid” or “illiquid”. While we are familiar with the idea that some assets such as property are illiquid and take time to sell, quoted assets may also suffer from a degree of illiquidity. 

For example, just over a year ago, at the height of the liability-driven investment crisis, it was almost impossible to find a buyer for UK gilts and in today’s market, investment trust managers such as Simon Gergel at Merchants are finding there are virtually no buyers for UK mid-cap shares outside the FTSE 100.

In times when prices are severely depressed by a buyer/seller imbalance, it usually makes sense to hold an asset for however long it takes for buyers to return to the market. But for a pensioner client this will require there to be other liquid and more immediately sellable assets within the overall portfolio in order to provide the cash required for retirement income.

Following this discussion with a client to determine what they really want and expect of their retirement income, the adviser can begin to select relevant retirement income products and underlying investments designed to meet their needs along the retirement journey. 

In times when prices are severely depressed by a buyer/seller imbalance, it usually makes sense to hold an asset for however long it takes for buyers to return to the market

The choice of the right product becomes much easier if the above factors have been considered. And if a compromise, or “a bit of both” option, is needed that too can be accommodated by blending, for example — holding some income drawdown and buying some guaranteed income from an annuity straightaway. 

Alternatively, the individual could be encouraged to start retirement in drawdown only and, at an optimum age for buying an annuity — guided by the financial adviser, actuarial calculations and stochastic modelling — everything left could be switched into an annuity.

Just do not leave that “flex first – fix later” strategy too long, as it is not comfortable for either client or attorney to be making large trades after intellectual competence has started to decline.

Adrian Boulding is director of retirement strategy at Dunstan Thomas