Oh to be young when retirement, if ever considered, is something for your parents to worry about and not for you. Having just passed my 58th birthday I was encouraging my son to start planning early as time slips by all too quickly and suddenly retirement is all too real and maybe even a little scary!
Given that retirement income will be needed for 20, 25 or even 30 years after you stop working, it is a pretty important issue.
Say you want to retire on £20,000 a year (not a fortune) at 65, the best annuity rate at the moment in the UK is just over 4.9%, which means you would need a pot of £408,163 to afford this.
Although this sounds reasonable, the figures above do not account for inflation; if prices rise at 3% a year, the value of that pension will halve by your 90th birthday.
The sheer cost of this explains why private sector employers have been dropping final-salary pension plans. Low bond yields mean that the cost of buying a guaranteed income has risen sharply.
Unfortunately, in the UK many seem to have used the introduction of Pension Freedoms to hold cash, an option that will give poor returns and no protection against inflation. Most pension members simply draw down an income without advice on how best to invest the funds used to provide it. This can leave them very vulnerable to market falls.
Many unhappy returns
This issue is just as true when building up a pension pot, as it is when taking an income.
The seemingly arcane debate about the discount rate on Final Salary pension liabilities hinges around this point. When an employer funds a pension for a worker, the bulk of the liability lies in the future—the need to pay an annual income after retirement. To work out the true cost, the future liability must be discounted by some rate to work out how much has to be contributed now.
The traditional approach has been to discount the liabilities by the expected return on the investment portfolio. This makes sense to a point, as pensions will be paid by a combination of employer/employee contributions and investment returns.
There are problems with this approach.
Firstly, no other liability would be treated this way. Suppose a company owed £100m to the tax authorities. It could take £60m of that money, and invest it in the stock market in the hope this would repay the debt. But it would not be allowed to record the debt as £60m in its accounts.
Secondly, what happens if the returns achieved are less than assumed? The employer will still have to pay the pensions anyway. The company could become insolvent, of course, and we have seen numerous examples of this resulting in losses for scheme members.
Thirdly, there is a temptation is to assume as high a return as possible in order keep contributions low. Many doubt whether pension funds can earn the level of returns they assume, especially when UK 15-year Gilt yields were around 1.5% in January 2019.
Economists say that a pension liability is a debt and should be discounted using a bond-like yield. This is the practice under international accounting standards and, as this is lower than the old assumed rate of return, it makes the liabilities look bigger and requires companies to contribute more, which explains why so many have closed their final-salary pensions.
This does not mean that pension funds have to invest all their portfolio in bonds, some do and some have an exposure to equities, property and hedge funds, believing these will earn a higher return than bonds. If the latter funds are right, there won’t be a problem in the long run although they remain exposed to a higher level of risk.
A wider problem
This brings us back to the original problem. It costs a lot to fund a pension.
Many argue that this is looking at the wrong issue: A high proportion of those working in the private sector lack any kind of retirement security, indeed in the UK, the average pension pot is around £30,000.
Dos and Don’ts for Saving for Retirement
- Do set up your own retirement savings
- Do seek pension advice
- Don’t rely on a state pension
- Don’t underestimate how much you need to save
- Don’t assume that your existing pensions are:
- The best pensions for your circumstances
- Working in the way you expect
- Will allow you to draw benefits how you want and when you want
So what now?
It is important that you understand these issues and how they may affect you, to ensure you plan for the retirement you want.
It is vital that you seek advice from a fully qualified specialist.
AAM Wealth Solutions can provide you with a detailed UK Pension Audit, which will consider these issues in light of your needs, goals and circumstances and make a recommendation showing the right course of action for you to achieve the best retirement outcome.
Why you should have an AAM Wealth Solutions UK Pension Audit now
Every AAM UK Pension Audit is overseen by Ian Black, a UK Qualified Chartered Financial Planner, who, in addition to being a Fellow of The Personal Finance Society, is a qualified Pension Transfer Specialist
An AAM UK Pension Audit, in addition to providing a full recommendation on your Optimum Pension, (whether that is the pension(s) you already have or an alternative) will put you in an informed position, enabling you to make an informed choice about how best to secure your perfect retirement.
Contact your AAM Wealth Manager now to arrange your UK Pensions Audit or email [email protected]
Op.ed piece by Ian Black, Director of Global Wealth Structuring, AAM Advisory
This article is an op-ed piece by Ian Black. The views expressed in this article are those of the author and do not necessarily reflect the views of AAM Advisory Pte Ltd. This document/article should not be construed as an offer, solicitation of an offer, or a recommendation to transact in any securities/products mentioned herein. The information does not take into account the specific investment objectives, financial situation or particular needs of any person. Advice should be sought from a licensed financial adviser regarding the suitability of the investment product before making a commitment to purchase the investment product. Past performance is not necessarily indicative of future performance. Any prediction, projection, or forecast on the economy, securities markets or the economic trends of the markets is not necessarily indicative of future performance. Whilst we have taken all reasonable care to ensure that the information contained in this document is not untrue or misleading at the time of publication, we cannot guarantee its accuracy or completeness. Any opinion or estimate contained in this document is subject to change without notice. The above report may contain data obtained from third parties and as such we cannot guarantee the accuracy of this data.