Morningstar's "Perspectives" series features investment insights from third-party contributors. Here, Jasper Berens, Head of UK Funds for J.P. Morgan Asset Management discusses solving the retirement conundrum.
The pensions revolution is now well underway, with George Osborne’s announcements bringing more clarity to the emerging post-reform framework. On the positive side, it’s clear that we are moving towards a less rigid pensions system that trusts long-term savers to make sensible decisions with their money. This should also boost the appeal of valuable initiatives like auto-enrolment, in turn helping to narrow the UK’s worrying retirement savings gap by encouraging more people to start saving for retirement earlier.
In the past, unless you had very substantial savings, your only option was to buy an annuity, with any lump sum left upon your death facing a draconian 55% tax. Under the new rules, pensions have been set free from their “locked box”. Now investors will have greater choice than ever before, with the freedom to use their pension pot as they like from age 55. What’s more, the end of the “death tax” is a strong motivation to keep money in your pension rather than spending it, leaving those funds for your retirement, or as an inheritance for your family.
Yet this greater freedom brings greater responsibility for savers themselves. Final salary schemes and annuities may be inflexible, but they come with the certainty of lifetime income–not something that should be tossed aside lightly. The worry is that investors may not have access to the right information to help them make prudent investment decisions for their financial future. That’s why it’s down to the financial advisory community to step up and meet the surge in demand for pensions advice.
For advisers, the top priority is solving the post-retirement investment conundrum. With “set it and forget it” annuities no longer the only option, what’s the best way to help clients to achieve a secure income stream in retirement without sacrificing total returns? And how do you balance diversification with capital preservation?
Let’s look at the biggest long-term investment challenges facing investors who choose not to buy an annuity:
Most of us will live longer than we think. If you’re 65 years old today, there’s a 47% chance that you or your spouse will live past 90 years old. Making sure your savings can last this long, while still achieving decent returns, can be a tricky balancing act.
Higher inflation means lower purchasing power in retirement. Price increases in particular categories—notably medical care—tend to have a disproportionate impact on older people. That makes producing an income that can stay ahead of inflation a constant challenge.
The hunt for yield continues as the squeeze on income tightens. Since 2007, average yearly council taxes are up 11%; household electricity bills are up 30%; the annual costs of running the family car and paying the family food bill are both up a shocking 60%. And thanks to record low interest rates, the value of £10,000 invested in cash 10 years ago would have lagged behind the rate of inflation by more than £2,000—a painful loss in real terms.
This last point is key for pension savers. Thanks to years of low interest rates and rising income needs, many people face a real danger of falling short of their long-term financial goals, or quite simply running out of money in retirement. Few income-seeking investors can easily absorb this kind of drop in interest payments, so they need to look elsewhere to make up for the loss.
Well-diversified multi-asset income funds provide a potential solution. By investing flexibly across a range of different income-producing assets – including dividend-paying equities, corporate and emerging market bonds, real estate securities and convertibles – multi-asset income funds can help to significantly reduce risks to capital, while ensuring that investors benefit from the higher potential income that comes with these higher yielding investments. What’s more, funds with a global, diversified approach are best equipped to seek out the best opportunities, wherever they are—helping to maintain income levels through a variety of market conditions.
The pension reforms of 2014 represent a huge step towards helping savers to maximise their pension pots—and enjoy the kind of retirement they’ve worked hard to achieve. But this is just the beginning of the story. With more reforms likely to change the shape of the pensions market, advisers face an unprecedented opportunity to help their clients reach their financial goals.
Disclaimer
The views contained herein are those of the author(s) and not necessarily those of Morningstar. If you are interested in Morningstar featuring your content on our website, please email submissions to UKEditorial@morningstar.com.
