20 years ago, 10-year gilt yield was 8%, 10 years ago it was 5.2% and today it sits at 1.35%. The sharp drop in income from government bonds has had a significant impact on investors – in particular those in retirement. In 2007, investors arguably had fewer options in retirement. Prior to pension freedoms introduced two years ago, unless you could prove you could provide yourself with a sizable income from private means you had to buy an annuity at retirement.
The rate at which your pension pot was converted into an annual income was based in part on the 10-year gilt yield – not bad when it sits at 5.2%, even better when it peaked at 12% in 1990. But not when it falls to below 2% as the UK endured a prolonged period of record low interest rates. It was little wonder the government felt pressure to scrap compulsory annuity purchase, when they were forcing pensioners to lock into such low levels of income for life.
But while annuities may no longer be compulsory purchase, government bonds remain one of the safest sources of income, and safety is a characteristic investors in retirement look for. With bonds and cash paying next to nothing, retired investors have been forced to take on portfolio risk.
Fewer Income Choices in Retirement
According to a new report from insurance group MetLife, entitled Guaranteeing Real Pension Freedom, a lack of guaranteed income products available in retirement is causing pensioners to take on risks. The survey also reveals one in five pension savers do not understand the choices available to them.
MetLife is calling for guarantees and guaranteed drawdown to form a central part of the Government’s new guidance framework. MetLife say the guidance is essential to help prevent investors taking on unnecessary investment risks in retirement because they don’t understand the choices they face.
Simon Massey, wealth management director at MetLife UK said: “Our research has uncovered a worrying gap in knowledge which has the potential to massively impact the retirement savings of a huge number of people.
“Despite almost half of savers taking more risk because of a lack of guaranteed income solutions for life, one in five admit they don’t understand the choices they face to generate this retirement income.
“We believe retirement conversations need to change to include a wider range of options – anything that encourages this, including guarantees and guaranteed drawdown to form part of the new guidance framework, should be supported across the board.”
Income Drawdown is an Option
Against the background of the UK pension freedom legislation, it is important that retirees have a reasonable expectation of the proportion of their assets they can withdraw each year to fund their cost of living, while ensuring sufficient capital remains to deliver a similar level of income into the future, says Dan Kemp, chief investment officer of Morningstar Investment Management. This is commonly known as the ‘safe withdrawal rate’.
Morningstar findings suggest that financial advisers and retirees in the United Kingdom should use lower initial safe withdrawal rates than noted in prior research; the lower end of the range now starts towards 2.5% or 3.0% and not the previous 4%. The generous capital market returns of the prior century that bolstered a comfortable and long-lasting retirement portfolio may give 21st-century retirees a false sense of security.
