Speaker(s): David Blake (Pensions Institute at Cass Business School)
We start by covering the keyrisks in retirement, such as interest rate risk, inflation risk, investment and reinvestment risk, and longevity risk. We then look at the components of a retirement financial strategy: investment strategy, the strategy for investing the pension pot; withdrawal strategy, the strategy for withdrawing cash from the pension pot to finance expenditures; and longevity insurance strategy. A good product for delivering retirement income needs to offer: accessibility, a degree of flexibility to withdraw funds on an ad hoc basis; inflation protection, either directly or via investment performance, with minimal involvement by individuals who do not want to manage investment risk; and longevity insurance. It is difficult for a single product to meet all these requirements, but a combination of drawdown and a deferred (inflation-linked) annuity does, for example. So a well-designed retirement income programme will have to involve a combination of products. Next we discuss the withdrawal strategy, and note that there is no safe fixed withdrawal rate that guarantees to last for the lifetime of the retiree (apart from a life annuity). Alternatives are: withdraw the annuitised value of the fund each year, known as the ‘equivalent annuity’ strategy; draw only the ‘natural’ income from the fund, defined as the ‘pay-out of dividends from income-generating investments’; auto-rebalancing, withdraw from asset classes that experienced the highest growth during the year; and cashflow reserve (or bond) ladder or bucket, hold enough in deposits or short-maturing bonds to meet the next two years of expenditure. We then consider the longevity insurance strategy, which determines when longevity insurance is purchased and when it comes into effect. The essentially boils down to the choice between: buying and immediate annuity when it is needed, and buying a deferred annuity at the point of retirement, with the deferred annuity beginning to make payments when it is needed. We end by designing a default retirement income/expenditure plan.