Let’s look at the retirement situation of three ‘average Joes’.
Joe 1 is an average person in his early 30s. The most important issues to him are putting a roof over his family, feeding and educating them.
The pensions industry tells Joe 1 he is not saving enough into his pension. His biggest outgoing is renting his home and if only he could find the deposit and get a mortgage he would be acquiring a valuable asset that may help with his retirement planning. One pension company (Royal London) has estimated that it costs £180k on average to rent throughout retirement.
Retirement however is a long way off for Joe 1 and if he did cut his pension contributions and trimmed his spending in other areas he could save for a house deposit. At current interest rates his mortgage repayments would be lower than what he now pays in rent. The Government are trying to help Joe 1. They promote various shared ownership and Help to Buy schemes to help him acquire his first home. If he saved into a Lifetime ISA he could also receive a bonus that would help with a deposit.
Joe 2 is 15 years older than Joe 1. He also is very average, has a mortgage and is paying into a pension. He is told that he should target a retirement income of 60% of his final earnings as a pension inclusive of his State pension. He used one of those tools that tell you your pension savings shortfall and it told him that if he moved his retirement age to 70, he would still need to contribute another £200 a month to his pension – more if he wishes to retire earlier.
Joe 2 reads stories about how poor pension investments are doing, how pension schemes going bust and how pension providers and advisers are ‘ripping off’ pension scheme members. Housing headlines however are often positive. Rarely do these headlines remind him of the 1990s when many experienced negative equity. Home ownership seems to be presented as a one-way investment.
Joe 3 is approaching retirement. He has an accumulated pension pot of just under £40k and owns his house outright which is worth £280k. He has spoken to PensionsWise about his pension options. Following those discussions he has approached several financial advisers about how he will convert his pension into retirement income.
Because of the low level of pension savings he found it difficult to find an adviser. When he did, Joe was very disappointed with the potential retirement income he was quoted – a tax-free lump sum of less than £10k, and an income of around £100 a month. Joe 3 has still not considered the three options he has regarding his housing wealth:
- Move to a smaller home; after transaction charges this could realise £50k. If this was done before retirement, and with wise use of pension tax allowances, this could boost his pension fund by £62.5k to just over £100k. The tax-free lump-sum has grown to £25k and his income has increased to around £300 a month. If the move takes place after retirement, a plan could be devised to live off the downsizing proceeds for 10 years, and then call on the pension savings for the remainder of life.
- Use equity release at some time in the future. If 20% of the house value was assumed to be within the pension pot, the true pension pot could be drawn down that much faster. As the pension pot begins to deplete, equity release drawdown facilities could be used to supplement the reduced pension income.
- Use a Retirement Interest Only mortgage. This would not be a viable option for Joe 3 but is included for completeness. Because of his limited income it is unlikely that he would meet the interest affordability criteria.
In its simplest form Retirement Planning is about building wealth while working, then living off that wealth in retirement. Most of the wealth in the UK is in houses and pensions. We should be encouraging individuals to be doing what is best for them, not encouraging them to make wrong decisions. In simple terms housing wealth cannot be ignored in retirement planning so:
- Joe 1 should be giving priority to housing over pensions. However, he should avoid giving up an employer pension contribution.
- Joe 2 should be giving priority to pension contributions. Due to the relative publicity pensions and housing receive it is probable he will still see extending his exposure to the housing market as an investment in the future.
- Joe 3 needs holistic guidance and advice on how to best combine his pension and housing wealth to meet the retirement outcomes he desires.
Thanks to auto-enrolment, close to nine million new pension savers have been created. Each month they are putting aside a small amount into their pensions and therefore over the next 25 years the average pension pot at retirement is still unlikely to grow. The numbers who are not attractive propositions for financial advisers will however grow enormously and a large number of them will be house owners.
The challenge to advice and guidance professionals is how they are going to meet the needs of this large number of people. What’s more the attitudes and probable actions of Joe 1 and 2 mean that demand for such services will be there for much longer than 25 years. What we do with that demand remains to be seen.
Bob Champion is chairman of the Later Life Academy (LLA)