Why technology is key to making pensions truly free
Five years on from the introduction of pension freedoms there's still much more the pensions industry can do to fulfil the promises of the legislation and meet the evolving needs of tomorrow's pensioners, writes David Simpson.
Until recently, retirement was generally a shift from working full-time to not working at all and needing a complete replacement income.
Except for the very wealthy, an annuity which gave a guaranteed level of income in retirement met most people's needs. But client needs are changing.
Nowadays, retirements are often stepped, with a gradual move from full-time to part-time work or a later life career change which may result in a lower salary, which may need topping up with income from a pension.
The decline of lucrative defined benefit pensions schemes is likely to fuel the trend for a steady descent from work into retirement as more people seek opportunities to continue earning after normal retirement age to supplement their state and pension income. Ageing clients will need tax-efficient income solutions that reflect the changing face of retirement, providing different levels of income at different stages of retirement, with additional lump sums for luxuries or unexpected expenses.
Freedom and choice
Pension freedom has also created more choice to meet our evolving income requirements. The latest figures from HM Revenue & Customs tell us that in the last quarter of 2019, £2.2bn was withdrawn from pensions flexibly, an 18% increase from £1.9bn in the fourth quarter of 2018. Clearly, demand for pension flexibility remains strong. Yet studies regularly report that fixed income, typically to cover monthly living costs, remains an important consideration when planning for retirement. For a growing number of clients, guaranteed income may form a crucial part of their finances in later life.
To meet these changing customer needs, pension products must also change to offer greater flexibility. Solutions that offer part guaranteed income (either for life or a term) to cover day to day living costs and part drawdown to fund travel and luxuries, part tax-free cash to pay off the mortgage, start a business or help out the children financially.
Part of the pot might stay invested for continued growth with the aim of passing on wealth to future generations. Clients may prefer to leave their whole pension invested and withdraw money from an ISA instead to avoid tax liabilities. As clients get older and their needs change, the ability to purchase guaranteed income benefits with portions of their pension funds may also be a valuable option as income from working reduces or to cover home help or care costs.
For instance, a client might want to reduce their working hours at 55 and take a term guaranteed income for 10 years to supplement their income and cover essential living expenses until pension benefits from an employer scheme start age 65.
At 60, they take a tax-free lump sum for a big holiday leaving the remainder of the fund invested in pension drawdown to hopefully continue to grow, with the adviser choosing from a broad range of investments to meet the client's needs and risk profile.
At 66, the client wants to retire fully. The state and employer pensions cover essentials, and further tax-free lump sums are taken out as required to pay for holidays and extras. Then at 75, ill-health means greater help is needed at home. A lifetime guaranteed income is purchased to cover higher living costs, benefiting from the enhanced rates now available to them under an impaired life policy.
When the client dies, their beneficiaries can access the remaining drawdown funds, with the adviser helping to manage the tax liabilities.
Ready and available
The technology is already available within the UK market to facilitate a combination of drawdown and term or lifetime guaranteed income within one pension wrapper with the ability to change the income levels as lifestyle and financial needs change. Yet the number of providers that offer such flexibility within their product range is currently very limited.
Of course, advisers can create similar flexible and guaranteed income solutions using different products side-by-side. But the capability to blend pension investments, drawdown and guaranteed income within one wrapper and alter the combination as required gives advisers far greater control over how much income their clients receive and when and how much income tax they pay throughout their retirement.
Deciding how to fund your lifestyle as you get older is a complex decision. To help clients with their long-term financial planning, the pension of the future should offer advisers as many options as possible to create a flexible retirement plan that adapts to changing income needs at 60, 70 and beyond.
At the recent The Investing and Saving Alliance's (TISA) annual retirement conference it was clear from the lively debate that advisers and providers agree in order to meet the income needs of future retirees, pensions will need to be more flexible.
Such flexibility already exists, but five years on from the introduction of pension freedoms there's still much more the pensions industry can do to fulfil the promises of the legislation and meet the evolving needs of tomorrow's pensioners.
David Simpson is head of EMEA at GBST