Throughout history, parents have made sacrifices to ensure their children would have better lives than they had.
However, Generation X is arguably the first generation in history that will have to double that sacrifice to ensure both their parents and their children have better lives than they can hope to enjoy. These are the people born in the 1960s and the 1970s. In the US they are sometimes called the “baby bust” generation, a name that these days some-how seems more apt.
Some of the baby boomers now approaching retirement might feel like they have much more in common with the baby bust generation than with their fellow boomers. Boomers who managed to jump on the final-salary bandwagon, whether public or private, have done well but those without access to an employer with deep pockets have discovered just how expensive providing a pension has become.
Our industry’s products were designed for much more benign investment conditions than we are experiencing. Annuities, for example, work best when there is a steeply upward-sloping yield curve. This was the case for decades, when buying an annuity meant accessing the juicy high yields available on long-dated bonds. There were some complications – inflation was a fairly constant threat – but bond yields often anticipated that threat.
One of the most striking things about the situation facing people retiring today is that long bond yields, and hence annuity rates, are at an historic low but inflation is not. For pensioners, inflation is much higher than the published levels due to the fact that the goods and services rising quickest in cost are the ones that take up a greater proportion of a retiree’s income compared with the incomes of the rest of the population. This includes items such as food, home energy and fuel.
If we believed this was a short-term phenomenon, there might be less cause for concern. After all, it is the expectation of future inflation that is important to today’s retiring population, not the past experience.
However, I am not sure we can be confident this is a short-term phenomenon. Can anybody really be sure that a protracted period of very low interest rates combined with sustained inflation in commodity and energy prices is out of the question? Given the seemingly insatiable growth in demand for commodities from Asia and the need to find alternative – and more expensive – sources of energy to tackle climate change, there does not seem to be much cause for optimism that inflation in these areas will subside any time soon.
The product solutions designed for the last generation are looking increasingly tired. Conventional annuities are already expensive and will remain so for the foreseeable future. Advisers’ clients find it difficult to accept that a fund of £50,000 that has taken years to accumulate will generate an inflation-linked income of just £30 a week. Conventional annuities could be the right choice for retirees who want to be assured of a regular fixed income but it is always important to review the alternatives.
The advent of enhanced annuities has made things better for customers who are ill at retirement but they just ensure that ill people get more of the pie and healthy people get less. If the size of the pie has reduced considerably because interest rates are so low, enhanced annuities do not help that situation at all.
I would suggest the solution, at least for those retirees with large pots, is obvious. Many people will have to take investment risk in retirement to give themselves a chance of earning a decent return on their money. That suggestion is likely to make a lot of people uncomfortable, and for good reason. Any adviser who is undertaking a drawdown review for someone who chose to take investment risk over the past few years will understand what the consequences can be. But again, I think the reason for this is the standard drawdown products on the market were also designed for a different era.
The industry needs to find better solutions that help customers balance the risks they should be worried about at retirement – longevity risk, inflation risk and investment risk. Please note the note word “should”. In reality, very few customers understand longevity risk, many ignore inflation risk and most avoid investment risk.
The best retirement advisers take the time to explain all these risks and help clients come to a sensible trade-off but the industry has work to do to make sure everyone has access to this high standard of advice.
Too often, customers end up in conventional annuities because they believe their risk tolerance to be low. By this, they often mean they have a low tolerance for a future reduction in income. Very often, these clients end up in a level annuity that maximises their exposure to future inflation, which is often justified on the basis that inflation-linked annuities are just too expensive.
I firmly believe that many customers, if properly educated about risks in retirement, will choose to trade risks.
By that, I mean they will accept investment risk – they will accept the risk their income might reduce if that is the price to be paid for the potential for their income to match inflation. The best advice and product solutions of the future will present these risks clearly and manage them appropriately, according to each customer’s attitude to each kind of risk.
It is true that this advice service is more complex that the traditional retirement advice given to baby boomers. But it is also considerably more valuable than a simple Omo rate comparison service.
Retirement advice is the fastest-growing segment in our industry. This means advisers providing professional advice that relies on a deep understanding of risk and the ability to communicate this to their clients – the late boomers and baby bust generation – will surely prosper.