What Pension Savers Can Learn from US Investors

American investors are turning to annuities to provide a steady stream of income in retirement, alongside target date funds and a private portfolio assisted by an adviser

Emma Wall 21 May, 2015 | 3:03PM
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Emma Wall: Hello and welcome to the Morningstar series, Ask the Expert. I am Emma Wall and I am joined by Morningstar's Matthew Radgowski to talk about retirement.

Hello, Matthew.

Matthew Radgowski: Hello.

Wall: So we've been hearing today at the Morningstar Investment Conference, how different retirement strategies around the world are different and similar to those in the U.K. And one of the most striking things about the U.S., I found is that, as a nation we are moving away from annuitising in the U.K. They've been tarred with this sort of ‘they're all bad’ brush and actually in the U.S. take up of annuities is increasing?

Radgowski: That's interesting. I think what we have found is that commonly, and this is something that existed in the U.S. a little while back in that the same misconceptions, the same, I'll say scepticism was certainly there in terms of the cost of those annuities, the role in the portfolio.

And I think it was unfortunately more of a binary decision, you either used an annuity or you did not, right. If you are an adviser that saw value in them, you tended to allocate quite significantly to client portfolios or you didn't. And what we saw then is quite frankly with the financial crisis a movement away from annuity purchase and you saw a stagnation in that market.

I think what we found though is that when used appropriately, right, as a tool within a portfolio setting they can create that floor level of income. So it allows an individual investor to sit down and say, okay, what are my discretionary expenses and what are my non-discretionary expenses. What is the minimum floor I need to actually support my needs in retirement; and utilising that annuity in that fashion actually changes the dynamic of the discussion.

Again it is not that blunt instrument, it is very surgical, it is very tactical and it is used within that client's overall portfolio. And I think within that conversation or that context more investors are willing to allocate smaller portions of their total portfolio to the guaranteed income options.

Wall: And that's, I suppose, that flexibility is already there in the mind of the investor, in the mind of the person approaching retirement because in the U.S. you'd never had to have this compulsory annuitisation. And I think one of the reasons that they have such a bad name in the U.K. is maybe it is just human nature, we don't like to be told what we have to do and choice is an attractive thing?

Radgowski: That's right, yeah. I mean, that pendulum right has swung. I think, it will find an equilibrium. And again, I think it is incumbent upon service providers like ourselves and others, advisers, product manufacturers to really educate the appropriate use, right.

Wall: And one other things that I thought was interesting about what you said is the concept that is not individuals who are choosing to annuitise, this is thing that is quite popular in the U.S. and retirement savings plan called a target date fund. Just basically pooled investments that work toward a particular date, you have high risk assets at one end and as you come towards retirement it gets less risky and then you can then either choose to go into a drawdown structure, but you stay within that product, don't you?

They are increasingly becoming popular in the U.K. and target date funds in the U.S. are using annuities to help provide some sort of income in retirement.

Radgowski: That's right. I think one of the biggest challenges we've had in the U.S. retirement marketplace is inertia. I mentioned that investors talk about they think, they believe, they feel that they have enough money when in reality they really don't. So these target date funds were used as a way to manage risk throughout that investor's lifecycle to ensure that the nest egg that they are able to accumulate is protected as their horizon risk grows.

But again we got to the point where now as we move through retirement into the spend out phase investors were now left to their devices, in terms of how they intelligently spend down.

And so the new developments are really focused around making sure in a measured way, very appropriately allocated to within the portfolio that there is a baseline level of income that's now secured in that target date offering. So; overcome that inertia, provide that base level of income but I still believe strongly that it doesn't alleviate the need for that adviser, that trusted adviser to sit down with that individual investor and say, okay, you have this income option, now.

But it is highly depended on the balance that you accumulate, which is highly dependent on the savings rate that you adopt. And so guiding them, coaching them that you may feel safe, you may feel secure which should only mean you need to up your savings rate even more. Those things together, I think, can really have a significant impact on investors' outcomes in retirement.

Wall: Matthew, thank you very much.

Radgowski: Thank you very much.

Wall: This is Emma Wall for Morningstar. Thank you for watching.

The information contained within is for educational and informational purposes ONLY. It is not intended nor should it be considered an invitation or inducement to buy or sell a security or securities noted within nor should it be viewed as a communication intended to persuade or incite you to buy or sell security or securities noted within. Any commentary provided is the opinion of the author and should not be considered a personalised recommendation. The information contained within should not be a person's sole basis for making an investment decision. Please contact your financial professional before making an investment decision.

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Emma Wall  is former Senior International Editor for Morningstar