We are living longer - so plan for it
Life expectancies are increasing - and while this is good news in many ways, it also means we have to rethink retirement. State pension ages are being raised in many places around the world by governments under pressure to stretch public funds further and individuals are being encouraged to pay more themselves in retirement.
In these circumstances, a growing number of workers are becoming more reliant on what are known as defined contribution (DC) pension schemes. Also known as money purchase plans, employees (and sometimes employers) pay money into a fund that is invested in financial markets. According to Reuters, quoting figures from the US Labor Department, the number of participants in DC pension plans rose from 11 million in 1975 to 67 million in 2007. Over time, the fund should grow to a size sufficient to provide a steady stream of income when the person stops working. Using this fund to provide income in retirement can be tricky.
Some choose to actively manage their investments while others may choose, or be required by law, to buy an annuity.
In its simplest form, an annuity guarantees payment of a fixed amount of money each month to a person until they die.
There are many forms of annuities including those that link the amount paid to the rate of inflation and those which split income between partners. Annuities can play an important part in retirement planning because they guarantee a certain income until death.
One of the main difficulties in planning retirement is the uncertainty about how many years your money must last. Someone who lives until their nineties will need more money than a person on a similar income who lives till seventy. This uncertainty is known in financial circles as longevity risk. Annuities provide a way to offset this uncertainty.
This benefit of offsetting this uncertainty, however, can come at a cost as the amount of money received from an annuity can be low. Companies that sell annuities need to ensure they have enough money to pay the person who survives into their 90s as well as those who die earlier.
With people living longer, the amount paid by annuities has tended to decline.
Furthermore, falling interest rates have also contributed to lowering annuity rates. One newspaper in the UK said that in 1995 a 65-year-old man with a £10,000 pension pot would have received £1,111 a year. In 2010 he would receive £606
It is sensible to take advice before buying an annuity as often the decision cannot be reversed or be very expensive to change. The number of types of annuity and of product providers means that people may find it hard to get the right information for them. Sometimes people with health conditions and unhealthy lifestyles can receive higher payments because of their shorter life expectancy. Often those approaching retirement can shop around to see which company offers the best rate. Online annuity calculators are available in a number of countries.
Don’t take risks
Alternatives to conventional pensions include buying a property to provide a rental income or moving to a country where the cost of living is cheaper. However either of these options will involve taking risky decisions, which people are not usually trained to handle, at a relatively late stage in life. Some may also choose to work longer although this may not be an option for those with health problems.
Older workers can take more modest steps to improve their retirement. A simple remedy is to look at one’s spending and savings plans and make adjustments.
For those with more time, it is necessary to plan ahead. Saving enough money to ensure you have sufficient income in retirement can be daunting.
However, it is possible, and this eZonomics video gives seven pieces of advice. The first is to start saving as early possible and let interest rates do the work for you.
Even though annuity rates have fallen, people who are five to 10 years from retirement can still take steps to improve their quality of life after work without taking investment risks they are not comfortable with.