Understand how retirement conversations are evolving with the first in a series of extracts from our thought-provoking report 'Redefining Retirement: Pensions Freedoms. Pensions Future'
Industry research, including our own, shows that people find it hard to articulate what they really need in retirement. They don’t understand how retirement income is achieved, they misunderstand key issues such as longevity risk, and as a result they tend to defer making decisions.
The paradox of pension freedom means that there are now many more choices available to people who are largely ill-equipped to make the necessary decisions or trade-offs - and who face potentially catastrophic implications if they make the wrong choices.
This Talking About Retirement series focuses on why in the new pensions landscape it’s all about the person, not the product, starting with the three main dilemmas faced by your clients and how you can address them.
The first dilemma now versus the future
Behavioural research has shown that, given the choice, people tend to choose a smaller-sooner reward over a larger-later reward.
Understanding this behaviour is key to unlocking (and ultimately changing) the irrational and short-term decision-making processes that are hardwired in the human condition.
In the past, clients were faced with the question of what level of income they could secure for the rest of their life. The only variables were external ones such as interest rates, inflation expectations, gilt yields and mortality. Some choices were irrevocable, and limited to deciding when to retire before accepting the best annuity on offer, and how to spend their tax-free cash.
The new reality is that clients are now being forced to calculate their life expectancy, their current and future spending patterns, future inflation and expected investment returns over a period likely to exceed 30 years.
The best strategy for most clients is to engage the services of an adviser who can help them attain enough confidence and competence to avoid making disastrous decisions.
The second dilemma visualising a long-term plan
Research* suggests that clients find it extremely difficult to visualise what they will require in retirement, often giving a figure reflecting what they feel they want - but with little focus on their actual need.
Research shows that clients pay scant regard to their income needs and merely settle for the income they could achieve, adapting their consumption to match. It also indicates that the vast majority have the following issues:
- Limited understanding during accumulation of how retirement income is achieved.
- A tendency to defer, or ignore, retirement planning.
- An understanding that shopping around is possible – but not doing so.
- Failing to understand the long-term ramifications of small differences in annual income.
*source: FCA behavioural insights - Ignition House December 2014
The problem arising from the first two issues is that by the time accessing retirement savings becomes a priority, it is often too late to make any difference to the outcomes that can be generated.
The new breadth of choice has been labelled freedom, but with freedom comes responsibility. By deciding against the security of annuities, clients are opting for a lifelong variable income and with it an acceptance of risk.
The third dilemma thinking the unthinkable
Many people are reluctant to openly address the implications of later life, such as long-term care for themselves and, indeed, for family members.
Despite overwhelming evidence that more and more individuals will require residential care at some stage, this very large elephant in the room continues to trumpet unheard.
The truth about what long-term care might really cost is a conversation that is often deferred, or ignored.
This is a subject, unpalatable or not, that needs discussion – ideally with the whole family unit, where the duty of care is central to the advice conversation.
Helping clients with the psychological adjustment
We have identified three retirement dilemmas clients face that need to be addressed - or at least recognised - by clients approaching their retirement. Accessing pension rights at the wrong time, ignoring all of the options available, and operating in ignorance of the rules could lead to bad decisions being made today with some ramifications only being felt in 15 or 20 years.
Underpinning most of the research is the sense that the vast majority of those approaching or beyond age 55 often don’t fully understand the problem they are trying to address, haven’t planned sufficiently well, and are not emotionally or behaviourally equipped to make decisions that have medium- to long-term ramifications.
This tends to encourage a decision based on the raw emotion of “how it feels” rather than an analysis of how the consequences might play out over a long period of time.
So, if it really is all about the person and not the product, the value of advice lies in the quality of the conversation. This leads to a deep understanding of the client’s individual needs.
Key client questions
To help clients make the psychological adjustment to the new way of planning for retirement, there are four main questions around which to frame client conversations. Each one relates to a risk involved in retirement planning.
Q1. How long will I live and need an income for? (Longevity Risk)
Q2. How much income do I need for the retirement I want? (Inflation Risk)
Q3. Is my money going to run out... Before I do? (Investment Risk)
Q4. What is the risk of not taking professional advice? (Unadvised Risk)
The Redefining Retirement report covers key conversations and opportunities for you to help guide clients through the evolving retirement landscape. Visit our website to find out more about our new retirement proposition, IncomeSelect.