At the end of June, the Financial Conduct Authority (FCA) published its Retirement Outcomes Review.
This was followed in July by the Pensions Policy Institute (PPI) publishing its own report entitled, Evolving retirement outcomes. Both reports provide excellent insights into how the pension income markets are working three years after the introduction of pension freedom reforms. But both contain a major failing.
Although mentioned in passing in the PPI report, the FCA does not include any analysis of how housing wealth is used to provide retirement income and the impact it has on the choices individuals make with their pension pots. Housing wealth, of course, can be used in retirement by downsizing, taking out a retirement interest only (RIO) mortgage or an equity release plan, usually a lifetime mortgage.
The latest activity report from the Equity Release Council indicates that 50,000 new equity release plans will be taken out in 2018. This compares with possibly 75,000 annuity sales and 120,000 moving into pension drawdown. To put this in perspective more individuals are taking out equity release plans than were moving into pension drawdown before pension freedoms when the number was about 40,000 a year.
Equity release is not the only way individuals access their housing wealth in retirement. How many downsize? Surveys indicate that two million over-55s plan to downsize to release money from their home. If spread evenly between ages 55-85, that is close to 70,000 a year. Combined that is 120,000 a year calling on their housing wealth in retirement – the same as those currently moving into income drawdown.
The RIO market can also only grow the numbers calling on their housing wealth as it offers the option of not moving home while protecting the equity in the home for bequests.
Assume the average retiree has a house worth around £300,000 and they withdraw 20% of their housing wealth, that gives another £60,000 to spend over their retirement. This compares with the current average £50,000 in pension pots currently being accessed. On this basis how can the wealth derived from housing not be included in a retirement outcomes review?
Some say that ISAs are more popular with savers than pensions because they do not come with complicated rules. The amount held in ISAs is certainly growing rapidly. However, soon the drawdown of ISA wealth will also impact on consumer behaviours as to how people draw their pension savings.
Locked up assets
Let us stick with the impact housing wealth has on pension savings. Firstly, if the average household can supplement their pension savings of £50,000 with £60,000 of housing wealth, how will that amount affect their use of their pension savings?
Common reasons given for using housing wealth are to pay off debts (this shows a lack of financial planning if the money has always been available); to help children and grandchildren, and to pay for treats and home improvements.
Some pension commentators are looking for pensions to provide ‘wage for life’ retirement outcomes and judge consumer behaviours accordingly. That is treating household finances in retirement as if they are no different to what they were in a working household. While we are working how many receive a guaranteed income that does not vary? When I started work many just received a basic salary or wage and the only variation was the availability of overtime.
Pay is now much more flexible. It rewards the worker by way of bonuses and other incentives for the good performance of the employer and the individual. Those bonuses and incentives can become almost non-existent when the employer is not doing so well.
While some may anticipate increasing living standards from career progression, many will experience interruption to their earnings through periods out of work following layoffs and redundancy. Then there is the growing number of self-employed who experience changes to their income based upon their activity which can be influenced by consumer confidence. The spending of a working individual depends upon how they see their future. If they are confident, they may take on debt to bring forward big purchases. A lack of confidence can result in putting something aside for a rainy day.
Retirement is different. The retiree becomes the owner of their personal wealth management business. The business may receive regular income from a state pension, a defined benefit pension or an annuity. If this is inadequate to meet their spending needs they need to manage the running down of the other wealth they have access to. If they spend faster than they run down their wealth, they will need to access credit.
While the position is improving, obtaining credit at older ages is not always easy. Particularly if the regular income is just about sufficient to meet their regular outgoings. Tax effectiveness and maintenance of wealth should influence how people run down their wealth. This can affect when pension assets are accessed. Proceeds from downsizing will not be in a tax-advantaged wrapper, therefore should they be used before any further pension assets?
Equity release may not normally be accessed until the pension assets begin to deplete. However, to mitigate potential inheritance tax liabilities equity release may be used while pension assets are left untouched.
As can be seen, retirement outcomes are influenced by a number of issues. To assess them by concentrating just on pension behaviours seems to be looking at the subject through a far too narrow lens. Regulators and others must look at the bigger picture.
Bob Champion is chairman of the Later Life Academy