It seems likely that many consumers are going to overspend in their retirement, says Bob Champion – so what does this mean for financial advisers?
I make no apology for referring again to a recent newsletter published by Retirement Advantage. In my last article, I commented on the use of safe withdrawal rates. In this one I wish to discuss why, in a survey conducted by Retirement Advantage, most people over the age of 50 felt it was safe to withdraw 7% annual income from their pension savings.
These are our customers so why did they respond with such a high number?
In the US, despite wide publicity being given to the 4% safe withdrawal rate, a significant number of pensioners draw down 8% income or more from their retirement savings. The UK equivalent of the US safe withdrawal rate is thought to be just below 3%. The difference is explained by the fact the US economy has grown faster than the UK economy in most of the periods under analysis.
The mass of data and computing power needed for such analysis is not available to the average consumer. So how do they arrive at 7%? Or, for that matter, why do their US counterparts draw down 8%?
Explanations are offered that the average consumer underestimates their longevity, or that they are overly optimistic concerning the investment returns they will receive on their pension savings. The average consumer is not, however, an actuary or an investment analyst. I believe we need to look elsewhere for the explanation.
I come back to the fact consumers are, by definition, spenders. In the UK, very few consumers have experience of unrestricted drawdown. While the age group may be generally cautious towards investment risks, their natural behaviour is to spend and consume. It is this natural behaviour that fuelled the, ‘it is safe to withdraw 7% income each year’ response to the Retirement Advantage survey. They did not consider the investment returns required to support such withdrawals – instead, it was driven by a natural spending desire.
It is too early to analyse what patterns are emerging from the pension freedom reforms. Will the UK consumer draw less than the 7% expectation? Or will their desire to spend, combined with the fact the money is accessible, mean they will draw down even more?
Does US experience give us a pointer? It could be argued US retirees are more optimistic about investment returns than their UK counterparts. As they age, however, their healthcare needs will have to be funded without a National Health Service to fall back on. Those in the US who draw down 8% may have greater health cost risks than their UK counterparts, which in theory should make them more cautious about spending their retirement savings too soon.
The not surprising conclusion is that many consumers are going to overspend in retirement. What does this mean for a financial adviser? What degree of overspending is acceptable before the consumer becomes an insistent client who is not accepting their adviser’s recommendations? What is the position if the adviser persuades a client to restrict the withdrawals from their pension savings but, at a review meeting, it transpires the client has accumulated a large credit card debt?
When faced with a consumer who is intent on overspending, the adviser should be able to demonstrate when it is probable the pension savings will run out. They also need to address at an early stage what other assets the consumer has that can be called upon to generate retirement income.
For many this will come down to releasing equity from the home. The practical issues surrounding downsizing, investment and drawing-down of the proceeds realised, and the various equity release schemes that are available, should therefore be discussed at least in outline form. This should include the consequences of such actions on legacies and so forth.
A holistic long-term strategy therefore needs to be developed and regularly reviewed as circumstances change. When the time comes, hopefully the move from being dependant upon pension savings should be seamless. The key objective, from the outset, is to avoid high spending clients getting into debt unnecessarily.
Bob Champion is chairman of the Later Life Academy