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Saving graces

Prudential product technical manager Andy Miller says longevity and better health in retirement mean people must rethink their saving mindset

We may not always like to admit it but I believe most people in the UK enjoy their job or at least get some degree of satisfaction from it. As well as generating an income, a job encourages us to interact with others, provides mental stimulation and gives feelings of self-esteem. But many of us are looking forward to the day when we don’t have to work any more, envisaging a long, happy and healthy retirement.

State pension provision
The goal of a long retirement may be more difficult to reach than some imagine. Longevity and better health into retirement are increasing but how will retirement be funded? And by whom?

A recent BBC survey suggested around 20 per cent of people in the UK believe the state – rather than the individual – is responsible for providing for them in old age.

This reliance may be misplaced because retirement income from the state is only likely to become more restricted in future.

Additionally, the state pension age has increased recently and will continue to do so. In the UK, most people reacted to this increase with resignation.

By contrast, our Gallic cousins in France, whose state pension age was increased to a mere 62, have paralysed the country with a general strike. Unfortunately, both reactions miss the crucial point. The pension environment has changed and people need to change their own approach to retirement saving in response.

Changing lifestyle
In the UK, it is normal for parents to support their children through further education and often for several years of employment as they may struggle to get on the housing ladder. Consequently, they are financially dependent for much longer than previous generations – perhaps into their late twenties or thirties. The result, combined with increased longevity, is the so-called “sandwich” generation – the same parents whose children have not yet flown the nest may be caring for their own parents as well.

Miller: ’Changes in lifestyle and the impact of inflation on the real value of income mean more people should consider flexible income solutions’

The longer time required to support dependents reduces the income available to save for retirement and could even continue into their supporter’s retirement.

Rapidly changing lifestyles are not new in the UK. As the 20th Century brought swift economic development, birth rates halved, falling from 3.5 children per family at the start of the century to about 1.7 by 1999. This experience has been mirrored worldwide – the less economically developed a country, the higher its birth rate tends to be.

On the face of it, this is illogical – the wealthier you are, the less of a financial burden children become as a proportion of income, so common sense should dictate that the wealthier a country is, the higher its birth rate should be.

This anomaly is called the “demographic economic paradox” and there are a number of theories as to why it should be true, such as increasing population density and the rise in women’s rights that a country experiences as it develops.

A contributory factor may be that in developing countries children are dependent for less time and, with no welfare system or pension provision, children are expected to care for their parents in their old age.

So it could be argued that children in developed countries constrain their parents’ ability to accumulate pension savings whereas children in developing countries are their parents’ pension provision.

Work until you drop?
Some have argued that retirement itself is an outdated concept. The state pension was originally introduced in the early 20th century but was revised to something close to its current model in 1948. Back then, the socio-demographics of the UK were very different. The average worker entered employment at 16, retired at 65 and was dead at 68. So workers paid tax and accumulated assets for almost 50 years in order to support a retirement income for only a few years.

Now, employment does not start for many until after higher education – perhaps aged 25 – yet retirement age for most remains at 65 and for many even earlier. Life expectancy from birth in the UK is now over 79 and the life expectancy of someone of retirement age is about 87-89. So, a significantly shorter employment has to support an average retirement of over 20 years.

One of the first consultations introduced by the coalition government was on the removal of the compulsory retirement age. This should be welcomed, as many people over 65 either need or want to continue to work. But most would accept that at 65 they are looking for flexibility in terms of their employment.

Replacing employment income

All these factors point to one thing – people’s saving behaviour needs to change. Where someone has pension savings, there is still the issue of how best to use those savings to replace employment income when they retire.

An annuity is the most appropriate solution for the vast majority of people. Annuity rates have fallen significantly in the last 20 years, largely because of decreasing fixed-interest yields and increa-sing longevity but increased longevity makes annuities more valuable since they are the only retirement income product to ensure that someone does not outlive their assets.

But changes in lifestyle and the impact of inflation on the real value of income over an extended retirement mean more people should consider flexible income solutions and investment-linked annuities, like modern with-profits annuities.

The end of retirement?
So, is retirement as we know it a thing of the past? A recent BBC poll asked 1,000 people if they thought it would be feasible to stop work, then live on a pension for up to 30 years.

Decisively, 70 per cent thought it would not. This survey demonstrates that people recognise the pension environment has changed and will continue to do so. The challenge is to channel that recognition into changed behaviours. Whatever uncertainties there are, the reality is that people cannot afford to do nothing in response.

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