Retirement planning: challenges for pension providers and retirees alike
Today, pension providers, such as insurers and pension funds, are facing multiple challenges regarding pensions communication. Not only is it often difficult to explain to clients or members what to expect in terms of their benefit payments. Also, people nowadays have an increasing number of options to choose from when arranging their retirement income. As a result, the personal responsibility of scheme members to achieve their required or desired post-retirement income is increasing. However, this does not relieve pension providers of their duty of care regarding their clients or members. Alternatively, providing guidance and communication about potential retirement income can even become a USP for pension providers to distinguish themselves in an increasingly more competitive market.
Multiple challenges for retirees
In the past, in many countries, retirement income consisted mostly of Defined Benefit (DB) pensions. As these pensions were guaranteed to both maintain the purchasing power and last throughout an entire lifetime after retirement, scheme members were not burdened with a vast array of planning options and challenges. However, as the costs of DB schemes have increased significantly, due to aspects such as longevity and low interest rates, Defined Contribution (DC) schemes are continually gaining ground. Within DC schemes, it is easier to respond to another trend: an increasing demand for freedom of choice. Greater freedom to choose, brings more self-responsibility. The decisions that people make regarding their retirement income may have severe consequences. A number of aspects have to be taken into account when making these decisions, for example:
- Longevity: besides the amount of retirement income, until what age can I expect this amount of income?
- Inflation: is my retirement income protected against a potential loss of purchasing power?
- Investment risks: are my retirement savings still invested in risky assets and am I comfortable with risk or able to bear potential losses?
- Flexibility: how much flexibility do I have, when choosing the amount of annual or monthly income?
In order to illustrate these aspects we show an example of a situation for a participant with a retirement age of 67. Currently, she has a pension capital worth € 200,000. This capital is invested within a Defined Contribution scheme and accumulates until retirement. The current net available income is € 40,000. The minimum required income after retirement is around € 20,000. The figures illustrate both the development of pension savings plus the (net real) retirement income shown as absolute income, relative to the pre-retirement income. The retirement income in this example is based on fixed drawdown pension savings. For each of the above-mentioned aspects, the situation can be reviewed.
To enable scheme members to plan their retirement income to cover these and other aspects, guidance and planning tools are necessary. As the post-retirement options vary from buying a - lifelong but nominal - annuity to a risky, but expected high and indexed pensions, insights into the consequences of choosing one over the other or a combination are essential.
Essential components for retirement planning
In order to provide guidance or advice to help scheme members with the choices they have towards their retirement planning, they need to understand several essential components:
A holistic overview of all retirement income:
Retirement income often consists of various sources of income such as a state pension, several pension benefits and/or other pension savings. In order to provide a clear overview of the total income after retirement these and also the income of spouses need to be taken into account. As the retirement dates of spouses may be different, an important aspect to investigate is whether there are pension gaps that need to be considered over time. To enable clients and members a clear overview of their financial situation, data aggregation is becoming more important. Several initiatives are already enabling this through a digital channel, making it easier to compile all relevant aspects of the financial situation in a heartbeat.
Insights into the amount of income actually required:
In order to ascertain whether the retirement income is sufficient, it is essential to estimate what the expenses after retirement will be. It is important to investigate both the minimum required expenses and the desired expenses. With a hybrid retirement income consisting partly of an annuity and a more flexible but risky drawdown scheme a client or member may actually achieve both goals at the same time. The expenses may include several components such as mortgage obligations, expenses for basic living costs, additional expenses to maintain the current lifestyle or any other specific expenses. Future personal expenses are easy or to estimate or generalize. However, recent technological developments in the field of Artificial Intelligence and Data Analytics make it possible for us to generate personalized expense profiles to an increasing extent.
In order to illustrate two different expense profiles, the figures below show a profile where the client expects to spend more in the early phase of retirement (left) and a profile where the client prefers to maintain the current lifestyle.
Scheme members need to have a clear overview of both total income after retirement and what is actually minimally required. With this in mind, pension providers can guide or advise their clients or members which options best fit each individual situation. By doing this, pension providers are offering their clients and members the tools for financial planning in an easily accessible way. Recent advances in automated advice mean that this can be done in a way that is both personal and efficient.
A challenge for pension providers
While providing the necessary guidance and insight to scheme members is very important, significant steps still need to be taken by the pension providers. Communication can still be improved to make the message more interesting, relevant and intuitive. However, we are seeing the first steps being taken to provide better insights into the options and consequences affecting retirement income. With these first steps, pension providers are positioning themselves more as a trusted partner of their clients or members. And by doing so, even consolidating their position within the market.