Entrepreneurs to annuitants – the new retirement dynamic
With the new pensions freedoms retirees are as likely to set up their own business as they are to buy a set of golf clubs, and their financial plans need to adapt accordingly, says Adrian Lowcock, head of investing AXA Wealth
What are the priorities of someone retiring today; what can they expect from their retirement? Generally speaking, the current generation of retirees are better off than the previous one. They have benefited from rising house prices and a bull market in shares (1980 to 2000) and this has been accompanied by significant improvements in standards of living and healthcare, meaning that many of the baby boomer generation are retiring in good health and good wealth.
The consequence of this is that many retirees are not actually ready to retire in the traditional sense and see it as an opportunity to do something else instead. The cliché of spending the days on the golf course or cruises are long gone. Some, of course, will use their retirement on hobbies, while others are considering using their pension funds to become their own boss.
These later life entrepreneurs are looking for ways in which to continue working and share the experience they have accumulated over their careers. Our research shows that one in 10 people approaching retirement were considering drawing down their pension pot to start their own business. This could range from building on a hobby, helping children with a business or setting up a franchise. For many people this will be a risky proposition, particularly using their pension fund in a venture where they could lose everything.
Clearly setting up your own business is not for everyone, but the pension freedoms also mean that many retirees can take complete control of their pension pot and become self-investors, possibly for the first time. The question for these people is where to begin. There are specific issues when investing at retirement. At this point we look to our investments to support us and replace the income we received when employed. Not only do we want an income but we are also looking for investments that will protect against inflation and are not too volatile. There are few funds able to deliver all three of these objectives but it is possible to construct a portfolio of different asset classes that can.
Finally we are still seeing plenty of people continue to buy annuities, even though the rates on offer are particularly low and unattractive. Annuities provide a huge level of security and comfort for many retirees who are not as adventurous or willing to take the risks of setting up their own businesses and want a guarantee, even though this can make them inflexible.
To work out how much money is available for any investment, including setting up their own business, retirees need a clear understanding of the issues and risks they face in retirement and therefore what they need to do to be prepared.
The risks in retirement
At AXA Wealth we have identified four key risks we think investors need to consider when managing their retirement:
Longevity: People are living longer in retirement than ever before, but also they are living longer than they expect. Therefore they need their investments and savings last for longer and retirees need to plan with the view they will live for much longer than they expect.
Flexibility: Spending habits change in retirement. At first, spending is generally higher as debts are paid off, holidays are taken and new hobbies enjoyed. As people become older and less active the spending falls, only to rise again as health worsens and care costs become a more significant factor.
Inflation: Inflation for 65 to 74 year olds between 2007 and 2014 was 27.3%, an average of 3.5% per annum and 4% higher than the national rate over the same period. Inflation of 3% per annum halves the spending power of money in 23 years. Even mild inflation over 20 or 30 years can have significant impact on wealth, so protecting against inflation will be essential for maintaining a desired standard of living.
Volatility: The value of investments rise and fall and any poor performance could be significantly detrimental to the value of a pension and the income received. The impact would be worst at the beginning of retirement and particularly if an income is taken directly from the capital.
Understanding the risks is the first stage of planning for retirement, the next is creating a solution.
The retirement framework
The retirement framework is a solution to help mitigate the effect of the four risks mentioned above. There are three layers of the framework:
Reliable income. The most important aim in retirement is to ensure that there is a certain amount of income coming in that is as reliable as possible. This income can be used to ensure that the essentials are always paid for and may come from the State Pension, an annuity or some guaranteed fixed income products.
Cash cushion. It is important to have some cash that can be accessed quickly and easily. Cash provides a cushioning effecting on any other pension pots. This cash can be used to cover short-term and discretionary spending. Holding up to three years of income in cash could mean that there is less concern that market volatility could halt any spending plans.
Diversified portfolio. Finally investments are required that include a mix of equities, bonds and other assets which have the potential to grow in order to keep ahead of inflation. Equities would form a natural core to this as they can provide capital and income growth to combat inflation and a mix of bonds and other assets to help reduce the impact of market volatility.
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