PENSION FREEDOM OR PENSION FEAR
For British people age 55+ with a defined contribution pension, being able to access the first 25% of your savings tax-free can be liberating. They can control how they spend the remainder with an income drawdown scheme. Annuities are no longer the only option. Regular payments can be taken from a pension fund and taxed as income. It is also possible to take the entire amount as cash and be taxed at the appropriate nominal tax rate.
But the risks of pension freedom are known. The wrong choice could reduce the income a person receives for the rest of his life. Decisions are irrevocable. The risk is not that a pre-retiree will squander money on a sports car. The risk is that pre-retirees do not have the right tools to manage their finances. Financial planning is typically undertaken by HNW individuals who have wealth advisers or trade union members who may get help from their industry groups, but not by ordinary people. The advice gap is in the middle. Therefore, many retirees are lacking the frameworks to plan for and safeguard their financial futures. According to the Pensions and Lifetime Savings Association, some 4.8 million British people aged 50-70 were fairly comfortably off during their working years but unused to budgeting, and they could not predict precisely how much they will have to live on in future, published in the PLSA’s Understanding Retirement study in 2018.
People who have assumed that an employer’s pension scheme or a financial planner will take care of their finances now wish to manage their own money. However, what they really need to do is manage three kinds of risk: market risk, longevity risk and inflation risk. Given the three types of risk that retirees need to manage, how can technology empower people to manage their pension assets in a strategic, systematic and safe way? A financial tool grounded in transparency of assumptions is the way forward.
Performance of markets is a source of anxiety. Retirees have lived through several business cycles and have seen boom and bust patterns of market movements.
A planning tool should include several capabilities, first of which is the ability to provide different scenarios from an economic scenario generator. Through a simple workflow, a customer can visualise what their portfolio looks like. Next, a balance sheet simulator, or a cash flow generator, can evaluate customer portfolios across the various scenarios provided by the scenario generator. The system is agnostic with respect to asset class and shows positions across equities, fixed income, cash and other assets consistently. Lastly, the system provides financial decision support. Some planners use a methodology based on modern portfolio theory; however, that approach is flawed as it typically underestimates the risk of certain decisions. At Kidbrooke, we employ a rational, measured approach based on utility theory. This allows for a more nuanced consideration of customers’ risk profiles, especially in conjunction with more realistic economic scenarios properly capturing the risk posed by economic crises.
This is the fear that pensioners will run out of money due to underestimating their life expectancy. Studies show that most people cannot predict how long they will live and how much income they will need to provide not only a good standard of living but, in the event of serious medical issues, the costs of long-term care.
The task of estimating lifetime financial needs is challenging. For example, a retiree may assume that once she turns 66, the state retirement age, she should start decumulation, converting assets to income. But at that age, there is still ample time for assets to accumulate and grow. The risk is that without modelling and decision support, retirees will make the wrong decisions.
Imagine a tool that enables a customer to forecast their expected lifetime income and expenses along with asset performance, using a scenario calculator. In the case of Kidbrooke, we offer a secure, stable and resilient way for pension administrators to present a variety of scenarios with decision support direct to customers. Consider Kidbrooke’s OutRank API, easy to use, transparent and highly customisable, used by Skandia Life, one of Sweden’s largest insurance companies.
While equities have produced superior returns historically, fixed income investments are seen to be more stable. The allocation of funds into equities considered an old rule of 100 minus your age. New approaches are less conservative. Retirees need to balance risk and reward; a simple, user-friendly tool empowers them to manage their finances in a way that is visually compelling and easy to understand.
A logical workflow provides a clean journey, that showcases different scenarios and hypothetical performance situations. As an example, Kidbrooke’s OutRank currently supports short-to-medium savings, credit advice, pensions, financial planning and liquidity forecasting, for a comprehensive view of the customer’s aggregate financial position.
FULFILLING YOUR FIDUCIARY DUTY
For pension trustees or advisers, making sure you fulfil your duty to protect your client is paramount. Any technology tool you offer to clients must uphold suitability requirements and data privacy standards, to ensure true, fair and accurate communication to customers.
At Kidbrooke, we focus on optimising customer interactions with a digitally enabled product that supports your internal operations, cybersecurity, data privacy, GDPR and other regulatory requirements. From a Risk, Compliance, Audit and Finance perspective, you can be confident in our trusted approach to information management.
A WAY FORWARD: RISK, REWARD AND POSSIBILITIES
A retirement plan is only as good as the assumptions used. Technology doesn’t need to be based on an opaque black box of impenetrable calculations; it can be designed around client needs, retaining full model transparency.
The key to motivating pensioner participation in managing their assets is usability. Consider Kidbrooke, where our team has conducted extensive user testing together with our partners to make our offering easily adoptable. With OutRank, you’ll find it easy to demo pension management/financial planning products to retirees with no experience of financial planning software. It’s a low-risk, high-reward option for empowering pension scheme members on the journey to retirement.
Get in touch today: kidbrooke.com
https://onlinelibrary.wiley.com/doi/abs/10.1002/cfp2.1007, Household financial planning strategies for managing longevity risk
https://www.pensions-institute.org/IRRIChapter4.pdf, Helping savers to manage longevity risk