More than nine years after the introduction of the pension schemes, people are still calling for help if they have an income.
You would think that helping people make the most of their hard-earned pension pots in retirement would be a national priority. But there is precious little government guidance on ‘good practice’ in this most difficult part of financial literacy.
As a nation, we need that help. Research from asset manager Abrdn, published this week, found that 23 million people (44 per cent of British adults) have poor financial literacy, reflected in their inability to answer basic questions about money. Nearly seven in ten (66 per cent) could not work out that buying a single company share is more risky than buying a fund that invests in the stock market on your behalf. And 42 per cent could not work out that if their money received an interest rate lower than inflation, it would lose its purchasing power.
Meanwhile, a new report from Scottish Widows has found a gap between what people want from their pension income and the products they actually choose.
Eight in 10 people said they wanted a product that offered a guaranteed income for life — but few customers buy annuity products that do. And more than half (55 percent) said a predictable income was important to them for budgeting, but most people currently choose a product where their income is tied to investment returns.
These are basic choices that can go completely wrong. But the actual choices are more complex: annuities come in many different varieties, with subtle but important differences. Furthermore, the majority who choose to draw down their income face several challenges in managing investments while generating income. Keeping up with inflation is one, while another is streak risk—the risk that negative market returns will occur early in retirement.
Pete Glancy, head of policy at Scottish Widows, said: “The options available in retirement can be daunting and complex, and people who cannot afford the services of an independent financial adviser may inadvertently make choices that are unsuitable for their needs and those of their family.”
Whether they get the right help, even if they can afford to pay for financial advice, is debatable. Readers may recall the findings of the Financial Conduct Authority’s Retirement Income Review in March, which revealed examples of bad practice in the market.
The regulator’s letter to the CEOs of consulting firms outlined the shortcomings. The approach to determining income recognition was applied without regard to individual circumstances, or was based on methods and assumptions that were not justified or documented.
Risk profiling was unsubstantiated, inconsistent with the client’s objectives, knowledge and experience, or failed to take into account their capacity to lose. And, perhaps most seriously, some advisors did not ask clients about their expenses, or explore future income needs or lifestyle changes.
Technology should be able to help. But there is a frustrating lack of free tools to help people see if their money will last until retirement. Guiide.co.uk is one of the few decent ones, although I hear more are in development.
Put all the findings together and we have hordes of financially illiterate people going it alone in the drawdown. It’s a terrible situation.
There are positives. I have seen anecdotal evidence of people doing drawdowns themselves with a well thought out strategy. But there has been little collective research into what drawdown clients without advisors actually do.
I am therefore pleased with the new report from Interactive Investor that sheds light on this.
The investment platform found that DIY drawdown clients have a higher exposure to investment trusts and funds and a lower weighting to cash than those in the accumulation or ‘growth’ phase of retirement planning. There is also evidence that drawdown investors’ use of investment trusts is designed to ensure a reliable and regular income from their investments.
Popular drawdown portfolio holdings include Alliance Trust, F&C Investment Trust and City of London, all of which are “dividend heroes” and have increased their payouts annually for more than half a century. This trio of Steady Eddies is also highly diversified, which helps to soften the impact of the inevitable volatility of stock market investing.
It is also worth noting that Alliance Trust has announced a blockbuster merger with Witan, which should reduce costs. The share price of both trusts rose on the back of the news, suggesting that the market believes the deal offers decent value to both sets of shareholders.
Interactive Investor also found that drawdown clients have increased their holdings of passive tracker funds over the past two years, with five of the top 10 holdings in drawdown now being passive funds. The platform believes investors are attracted by the low costs and simplicity of the approach.
This all seems very sensible. An October 2023 paper by Anarkulova, Cederburg, and O’Doherty found that a simple, all-equity portfolio outperforms alternatives across all retirement outcomes, generating more wealth in retirement and allowing for higher initial retirement consumption. Surprisingly, the all-equity strategy also performed favorably on capital preservation, with households less likely to deplete their savings and more likely to leave behind a large inheritance.
Meanwhile, a forthcoming publication from pension income adviser Chancery Lane attempts to shed light on the question of how a pension is invested. I’ve had a taster of its analysis, which calculates the income and capital generated by investing £100,000 in different types of portfolio over the 20 years to 31 December 2023 versus the return on a retail price index-linked annuity.
It found that mutual funds delivered the best overall performance, and concluded that dividend income growth from 29 mainstream mutual funds is also likely to “cope with” inflation. I’ll note that the period analyzed in the study was particularly strong for stock market gains, but Chancery Lane CEO Doug Brodie says: “Income from a stock is determined twice a year by a board of directors using cash they already have, whereas capital values are a simple reflection of this morning’s stock trade.”
It is food for thought. And we need more of this kind of research, especially independent research without ulterior motives.
There have been many calls for policymakers to focus on the near-retirement, growth-stage group (and younger people) to encourage them to increase their retirement provision. But they also need to ensure that people can confidently visualise their retirement income and how it will be generated. It may require significant innovation. And it will certainly require investment in education.
That’s because the optimal retirement income solution sometimes comes with a level of discomfort. An investor can be uncomfortable and still get a good outcome. Or they need to be uncomfortable to have a chance at a good outcome. Education will help them accept this.
To build on the success of auto-enrolment and help people manage the key income decisions they face effectively, we need cross-party consensus. With political upheavals likely in the coming months, it is time for an independent commission on long-term savings to focus on retirement income and help solve some of these issues.
Moira O’Neill is a freelance money and investment writer. She is the owner of F&C Investment Trust and City of London. X: @MoiraONeillInstagram @MoiraOnMoneye-mail: moira.o’neill@ft.com