Revolution is an over-used word but, in the case of pension freedoms, it is necessary. The consequences of ending de-facto compulsory annuitisation in the mass retirement market will be felt for decades to come. Such is the nature of revolutions.
This does mean a final judgment on pension freedoms’ success or otherwise remains some time away. That said, three years on from the policy announcement and two from its introduction, a provisional perspective is possible.
For myself – as someone who sat gobsmacked on the Opposition Front bench when then-chancellor George Osborne announced the policy in his 2014 Budget – the freedoms now appear a logical step in a wider global shift towards the individualising of retirement risk.
The fundamental trend in pensions around the world is the transfer of investment risk from governments (by reducing state pension entitlements) and employers (by exiting defined benefit) to individuals.
Do-it-yourself is increasingly the new reality for retirement. Longevity risk, investment risk, inflation risk: it is now the task of the adviser to manage these for clients.
Doing so was once the role of life company actuaries, who used mathematical models, statistical techniques and time estimates of life expectancy. With the overall liabilities capable of being projected, and the assets necessary to meet those liabilities calculated, the life company sought the appropriate mix of investments.
The adviser’s task is more challenging in the world of freedom and choice. The pooling that defines actuarial science is absent. Actuarial projections might not always have been accurate – but they were possible.
It is more complex for an adviser. After all, an individual is either dead or alive; there is no average longevity to project. Judging how long an individual life will last is an art, not an (actuarial) science.
The great advantage the adviser has is a deep understanding of their client’s circumstances and, therefore, their needs. Retirement is individual. There are so many variables at play, whether in terms of health, dependents, tax, bequests or indeed lifestyle. A quality adviser-client relationship opens up the possibility to better tailor retirement savings to personal goals in a way that actuarial pooling simply cannot.
But, of course, with greater freedom and choice comes great responsibility. As advisers take on the task of making more clients’ retirement incomes last a lifetime (or, indeed, longer if bequest is an objective) so the managing of risks falls to them.
Inflation, for example, is a silent thief. It is not something most people think about on a daily basis but, as life expectancy continues to rise, there is more time for its insidious effect to take hold.
It is essentially the time decay of money, gradually eroding one’s purchasing power, and hedging against its impact is often expensive.
But time can work in your favour, too. On the investment side, it cannot be said enough. The power of compound returns is the eighth wonder of the world. It demonstrates that time literally is money. Thus, saving earlier is crucial. Larger contributions later on simply will not enjoy the same compounding effect. By a similar token, sharp and unfortunate drops in the value of a retirement pot just before or after you start to draw an income
can be tough to recover from, even when the average return is reasonable over the course of retirement investing.
So, two years on, pension freedoms are offering real flexibility to clients and more opportunities for high quality advice. But the challenges involved with responsibility are more important than ever. The kaleidoscope has been shaken but the pieces remain in flux.
Gregg McClymont is head of retirement at Aberdeen Asset Management