tag:theconversation.com,2011:/ca/topics/annuities-11523/articlesannuities – The Conversation2023-08-03T12:56:46Ztag:theconversation.com,2011:article/2103442023-08-03T12:56:46Z2023-08-03T12:56:46ZHow the Bank of England’s interest rate hikes are filtering through to your finances<figure><img src="https://images.theconversation.com/files/540992/original/file-20230803-15-rds3cq.jpg?ixlib=rb-1.1.0&rect=20%2C28%2C2685%2C2231&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">The Bank of England, London.</span> <span class="attribution"><a class="source" href="https://www.shutterstock.com/image-photo/london-uk-june-11-2015-people-451939666">Claudio Divizia/Shutterstock</a></span></figcaption></figure><p>The Bank of England has <a href="https://www.bankofengland.co.uk/monetary-policy/the-interest-rate-bank-rate">increased interest rates to 5.25%</a>, a level not seen since April 2008 and markedly higher than the all-time lows of 0.1% seen less than two years ago.</p>
<p>In fact, interest rates hovered between 0.1% and 0.75% for the 13 years to May 2022. We are now in a new era in which the Bank of England – similar to other central banks – is using rate hikes (this is the 14th consecutive increase) to try to bring price inflation down from currently just under 8% towards its <a href="https://www.bankofengland.co.uk/monetary-policy/inflation">target of 2%</a>.</p>
<p>The bank’s goal is to increase the cost of borrowing for retail banks, which then pass these costs on to households and companies. This reduces people’s spending and causes prices to rise more slowly as companies adjust to falling demand.</p>
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Read more:
<a href="https://theconversation.com/interest-rate-hikes-are-not-the-only-tool-to-fight-uk-inflation-heres-what-the-government-should-do-208697">Interest rate hikes are not the only tool to fight UK inflation – here's what the government should do</a>
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<p>But interest rates are often called <a href="https://theconversation.com/why-uk-inflation-is-so-high-compared-to-eu-and-us-and-what-to-do-about-it-206583">a blunt instrument</a> because adjusting them to tackle inflation has <a href="https://www.aeaweb.org/articles?id=10.1257/jep.37.1.121">an uneven effect</a>. This is because people are at different stages of their lives and have varied levels and sources of income, not to mention debt. </p>
<p>So, there are winners and losers. Here are the main factors that influence how rate changes could feed through to your finances.</p>
<h2>Do you have a mortgage?</h2>
<p>Perhaps the most obvious impact of rising interest rates is increased mortgage repayments. This tends to affect younger generations (but not the youngest) and those in the middle of the wealth distribution the most. Higher interest rates <a href="https://academic.oup.com/restud/article-abstract/87/1/102/5272505?redirectedFrom=fulltext">lead to a fall in spending</a> among these groups that is greater than the increase in their mortgage costs, which is what the bank wants to encourage.</p>
<p>However, the worst is yet to come for UK mortgage borrowers. Back in 2008, the bank started cutting interest rates to support the economy after the global financial crisis. At this time, the fee for ending a mortgage deal early to switch to a lower interest rate was often <a href="https://papers.ssrn.com/sol3/papers.cfm?abstract_id=4399613">outweighed by the savings gained</a> from the lower rate.</p>
<p>As more borrowers have been on fixed-rate mortgages as a result, people’s actual rates have risen much more slowly than the advertised rates for new mortgage deals. This chart, which includes all current UK mortgage deals, shows that rate rises have so far largely only affected variable- or floating-rate deals:</p>
<figure class="align-center ">
<img alt="Line graph showing various mortgage product repayment rates, all fairly level, slight increase, but variable rates have increased significantly." src="https://images.theconversation.com/files/540985/original/file-20230803-15-flfgk9.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/540985/original/file-20230803-15-flfgk9.png?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=526&fit=crop&dpr=1 600w, https://images.theconversation.com/files/540985/original/file-20230803-15-flfgk9.png?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=526&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/540985/original/file-20230803-15-flfgk9.png?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=526&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/540985/original/file-20230803-15-flfgk9.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=661&fit=crop&dpr=1 754w, https://images.theconversation.com/files/540985/original/file-20230803-15-flfgk9.png?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=661&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/540985/original/file-20230803-15-flfgk9.png?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=661&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px">
<figcaption>
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<span class="attribution"><a class="source" href="https://www.bankofengland.co.uk/statistics/visual-summaries/effective-interest-rates">Bank of England</a></span>
</figcaption>
</figure>
<p>In contrast, this chart, which includes only new mortgage deals agreed since August 2021, shows how interest rate rises are similarly affecting repayments on all types of new deal:</p>
<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/540986/original/file-20230803-19-6dd92w.png?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="Line chart showing sharp rise in mortgage repayment rates" src="https://images.theconversation.com/files/540986/original/file-20230803-19-6dd92w.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/540986/original/file-20230803-19-6dd92w.png?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=526&fit=crop&dpr=1 600w, https://images.theconversation.com/files/540986/original/file-20230803-19-6dd92w.png?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=526&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/540986/original/file-20230803-19-6dd92w.png?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=526&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/540986/original/file-20230803-19-6dd92w.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=661&fit=crop&dpr=1 754w, https://images.theconversation.com/files/540986/original/file-20230803-19-6dd92w.png?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=661&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/540986/original/file-20230803-19-6dd92w.png?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=661&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
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<span class="attribution"><a class="source" href="https://www.bankofengland.co.uk/statistics/visual-summaries/effective-interest-rates">Bank of England</a></span>
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</figure>
<p>As rates rise, only those who have to refinance will choose to move to a new loan, so the effects are likely to filter through at a slower pace. But it will happen – the 4 million borrowers expected to move to new mortgage contracts over the next three years could pay <a href="https://www.theguardian.com/money/2023/jul/12/mortgage-payment-rise-bank-of-england-2026-forecast">up to £220 more a month</a> because of the current higher-rate environment.</p>
<h2>Do you own your home outright?</h2>
<p>House prices are widely expected to fall in coming months as <a href="https://www.aljazeera.com/economy/2023/8/1/uk-house-prices-drop-by-most-since-2009-amid-rising-interest-rates">rate hikes make it more difficult</a> to get a mortgage – but this will only affect people who want to buy or sell. While your house may be worth less, if you remain living in it you still get to enjoy your home regardless of its price. </p>
<p>However, a house can also be a valuable source of collateral or security for repayment of a loan, so lower house prices can mean less opportunity to borrow in difficult times. This is particularly important for <a href="https://www.jstor.org/stable/26543941">older generations</a> who may need to pay for long-term care.</p>
<h2>Do you have a pension or savings?</h2>
<p>On the other hand, older generations (and wealthier households) may benefit from higher rates because they’ve had more time to accumulate wealth. </p>
<p>Rate hikes can boost returns on savings and fixed-income assets such as bonds and <a href="https://benjaminmoll.com/wp-content/uploads/2021/11/APR_slides.pdf">annuities</a> (which provide <a href="https://www.ageuk.org.uk/information-advice/money-legal/pensions/annuities/">a fixed income stream</a> in retirement). For example, a typical 65-year-old looking to purchase an annuity with a £100,000 pension could get <a href="https://www.sharingpensions.co.uk/annuity-rates-chart-latest.htm#:%7E:text=Latest%20annuity%20rates,-How%20annuity%20rates&text=The%2015%2Dyear%20gilt%20yields%20increased%20by%20%2B10%20basis%20points,yields%20remain%20at%20current%20levels">up to £7,352 per year</a> now, compared with £4,786 at the start of 2021.</p>
<p>On the other hand, higher interest rates can make investing in the stock market less attractive. Reduced spending by the public means companies make less money for shareholders.</p>
<h2>Do you rent your home?</h2>
<p>The cost of living crisis, competition for rental properties and lack of supply of housing has led to a significant increase in costs for renters. But are they winners or losers when it comes to increases in interest rates? The picture is mixed. </p>
<p>Landlords may initially pass higher mortgage costs to renters. But, as more landlords exit the market, lower house prices could eventually cause rents to fall, as landlords need less to cover mortgage repayments. In the medium term, evidence suggests that higher interest rates ultimately <a href="https://www.frbsf.org/economic-research/publications/economic-letter/2023/february/can-monetary-policy-tame-rent-inflation/#:%7E:text=Evidence%20suggests%20that%2C%20as%20monetary,tends%20to%20adjust%20relatively%20slowly">reduce rents</a>. </p>
<p>However, renters tend to be younger, less well off, and often living paycheck to paycheck, which is more likely to leave them worse off overall.</p>
<figure class="align-center ">
<img alt="Two red and white signs saying " src="https://images.theconversation.com/files/540988/original/file-20230803-27-fpyrml.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/540988/original/file-20230803-27-fpyrml.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=400&fit=crop&dpr=1 600w, https://images.theconversation.com/files/540988/original/file-20230803-27-fpyrml.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=400&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/540988/original/file-20230803-27-fpyrml.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=400&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/540988/original/file-20230803-27-fpyrml.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=503&fit=crop&dpr=1 754w, https://images.theconversation.com/files/540988/original/file-20230803-27-fpyrml.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=503&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/540988/original/file-20230803-27-fpyrml.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=503&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px">
<figcaption>
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<span class="attribution"><a class="source" href="https://www.shutterstock.com/image-photo/red-rent-sign-details-on-front-685694197">Andriy Blokhin/Shutterstock</a></span>
</figcaption>
</figure>
<h2>Do you live paycheck to paycheck?</h2>
<p>A rise in interest rates tends to mean that things become more expensive, so <a href="https://www.cato.org/research-briefs-economic-policy/expansionary-monetary-policy-increases-inequality?utm_campaign=Research%20Briefs%20in%20Economic%20Policy&utm_medium=email&_hsmi=200695551&_hsenc=p2ANqtz-_RH3P0DhUGejoN8yynX39-0Cag6DT3zwhSsvUl9f03yFSUoZmjbzlxxlNL6S_qJPx0ceYowguVC0GUmGSSE8j31q_gnw&utm_content=200695551&utm_source=hs_email">people spend less</a> and companies are unable (or don’t want to) pay workers enough to match the rise in prices. So, if even your take-home pay stays the same (or even goes a bit higher), the amount of good services you can buy with your wages falls. </p>
<p>This probably adversely affects those on lower incomes the most. The last time there was a major increase in interest rates in the 1970s, earnings losses from low-income households were <a href="https://www.jstor.org/stable/10.1086/675535">many times</a> that of high-income households. And when we consider the effects of lower incomes on spending, the gap between richer and poorer households is even greater. This is because people with no savings cushion are forced to reduce their consumption when prices rise. Around a third of UK workers are currently <a href="https://www.wtwco.com/en-gb/news/2022/06/a-third-of-uk-workers-are-living-payday-to-payday">in this category</a>.</p>
<p>On the other hand, the wealthy can draw down savings – including <a href="https://www.theguardian.com/business/2023/jun/29/uk-households-withdrawing-savings-at-fastest-ever-rate-official-figures-show">savings built up during the pandemic</a> – and continue to spend.</p>
<p>Understanding and measuring the varied impact of rate changes in the current era of increases is crucial. This should be a top priority for economists and policymakers who want to achieve stable price inflation and grow the economy, while also protecting the most vulnerable.</p><img src="https://counter.theconversation.com/content/210344/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>William Tayler does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>Interest rate rises have an uneven effect depending on your savings, living conditions and stage of life.William Tayler, Assistant Professor in Economics, Lancaster UniversityLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/2063622023-06-05T15:57:29Z2023-06-05T15:57:29ZWhy saving for a pension has become more risky<figure><img src="https://images.theconversation.com/files/528068/original/file-20230524-33669-p13c5d.jpg?ixlib=rb-1.1.0&rect=0%2C0%2C4992%2C2979&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">
</span> <span class="attribution"><a class="source" href="https://www.shutterstock.com/image-vector/vector-illustration-risk-challenge-business-concept-714831775">inamar/Shutterstock</a></span></figcaption></figure><p>How much money are you going to have to live on in retirement? Perhaps, just like <a href="https://www.unbiased.co.uk/news/financial-adviser/one-in-three-brits-don-t-know-how-much-pension-to-save">one in five Britons</a>, you do not know. </p>
<p>This is not a surprise since there are so many shifting factors, or risks, to consider when thinking about retirement finances. You need to think about how much you’ll earn during your life, to what your employer will decide to contribute towards your a pension, and how much tax you will have to pay. </p>
<p>And then, even for the (fairly simple) <a href="https://www.gov.uk/browse/working/state-pension">state pension provided by the government</a>, there is “policy risk” to think about. This refers to how big your pension pot will be by the time you retire, not to mention <a href="https://www.ageuk.org.uk/information-advice/money-legal/pensions/state-pension/changes-to-state-pension-age/">when you will able to claim it</a>.</p>
<p>What this uncertainty means is that, almost irrespective of how much you earn, <a href="https://ifs.org.uk/pensions-review">most of us face a lot of risks</a> when it comes to our retirement finances. And unfortunately, you are likely facing more now than perhaps your parents did 25 years ago.</p>
<p>Back then, most of the uncertainty around pension pots came from not knowing how much you would earn over the course of your career. People typically had traditional occupational pensions, known as <a href="https://www.moneyhelper.org.uk/en/pensions-and-retirement/pensions-basics/defined-benefit-or-final-salary-pensions-schemes-explained#:%7E:text=A%20defined%20benefit%20(DB)%20pension%20scheme%20is%20one%20where%20the,year%20in%20line%20with%20inflation.">defined benefit</a> or final salary pensions. These were basically a promise from an employer that they would invest enough money to ensure their employees were paid a particular amount from retirement at 65 until death. That amount would depend on a person’s earnings and length of service. </p>
<p>Some people did not have occupational pensions, but instead had <a href="https://www.unbiased.co.uk/discover/pensions-retirement/managing-a-pension/what-is-a-serps-pension">state earnings-related pensions</a>. With this type, higher earnings meant paying more in national insurance contributions, resulting in a higher state pension in retirement.</p>
<p>And so, 25 years ago it didn’t really matter how well the stock market did – if an employer’s investments did not cover their pension promise to employees, they had to top it up (and often did so, leading to companies having “<a href="https://www.investorschronicle.co.uk/news/2022/05/12/ftse-350-firms-pension-deficits-shrink-to-lowest-level-in-two-years/">pension deficits</a>”). But for employees, it didn’t matter if they lived longer than expected, their company, or the government, would pay their pension for as long as they lived. </p>
<p>These risks – investment risk (how well the stock market and other assets do) and longevity risk (the risk of living much longer than expected and running out of money) – were not a big concern for people with pensions in the past. But the changing nature of UK pensions in recent years has caused these risks to be transferred from the government and companies to anyone saving into a future pension pot.</p>
<h2>New retirement risks</h2>
<p>For a variety of reasons (including the amount of risk employers had to bear in the past) <a href="https://www.pensionspolicyinstitute.org.uk/media/3916/20210923-the-dc-future-book-2021-final.pdf">barely any organisations</a> outside the public sector offer traditional defined benefit pensions these days. Instead, on top of a state pension – which is now a flat-rate, no longer earnings-related – most people saving for retirement do so in a <a href="https://www.pensionbee.com/pensions-explained/pension-types/what-is-a-defined-contribution-pension">defined contribution</a> pension. </p>
<p>At its core, a defined contribution pension is a tax-advantaged savings account that you and your employer contribute to, and which you can only access in your late 50s. When you do access it, you simply have a pot of money. </p>
<p>If you are very lucky in terms of what you have chosen to invest in (Amazon shares in the early 2000s maybe), your pot will have done very well. If you are unlucky (and you owned funds which were invested in companies that went bust, for example), you won’t have done as well as an Amazon-owning colleague – even if you contributed the same amount.</p>
<p><strong>Amazon’s rising share price</strong></p>
<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/528065/original/file-20230524-15-b3n9co.png?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="Line chart showing Amazon share price rising since 1990s." src="https://images.theconversation.com/files/528065/original/file-20230524-15-b3n9co.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/528065/original/file-20230524-15-b3n9co.png?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=329&fit=crop&dpr=1 600w, https://images.theconversation.com/files/528065/original/file-20230524-15-b3n9co.png?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=329&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/528065/original/file-20230524-15-b3n9co.png?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=329&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/528065/original/file-20230524-15-b3n9co.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=414&fit=crop&dpr=1 754w, https://images.theconversation.com/files/528065/original/file-20230524-15-b3n9co.png?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=414&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/528065/original/file-20230524-15-b3n9co.png?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=414&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
<figcaption>
<span class="caption">We’d all like some Amazon in our pension pots.</span>
<span class="attribution"><a class="source" href="https://www.tradingview.com/chart/">TradingView</a></span>
</figcaption>
</figure>
<p>Longevity risk is also now a factor to consider. This is the risk that you will live for a very long time and run out of money. </p>
<p>One reason for this is that, <a href="https://www.theguardian.com/money/2014/mar/22/death-compulsory-annuities-pension-revolution">since 2015</a>, retirees no longer have to turn their “pots” of defined contribution pension savings into an “annuity”. This is a stream of income that’s guaranteed until death. </p>
<p>Instead, most people simply spend their pensions pots any way they like now. But this means living much longer than expected increases the risk of completely depleting your private pension savings.</p>
<h2>Pension risk transfer</h2>
<p>One obvious question is: if pensions are now so risky, why don’t people pay to guarantee an income in retirement? That is, why doesn’t the government bring back annuities? When they were required, many people felt they weren’t getting a good <a href="https://www.moneymarketing.co.uk/opinion/steve-webb-keep-your-eyes-on-comeback-kid-annuities/">deal out of these products</a> – they were paying a lot upfront for only a small guaranteed annual income. </p>
<p>But while removing compulsory annuitisation is generally thought to be a popular policy – and it certainly gives people the freedom and opportunity to match their income with the way they want to spend in retirement – it also increases the risk of running out of private resources before you die.</p>
<figure class="align-center ">
<img alt="Woman with grey hair, sunglasses and surf board standing at the edge of the sea." src="https://images.theconversation.com/files/528067/original/file-20230524-27-hqgdxo.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/528067/original/file-20230524-27-hqgdxo.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=361&fit=crop&dpr=1 600w, https://images.theconversation.com/files/528067/original/file-20230524-27-hqgdxo.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=361&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/528067/original/file-20230524-27-hqgdxo.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=361&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/528067/original/file-20230524-27-hqgdxo.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=454&fit=crop&dpr=1 754w, https://images.theconversation.com/files/528067/original/file-20230524-27-hqgdxo.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=454&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/528067/original/file-20230524-27-hqgdxo.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=454&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px">
<figcaption>
<span class="caption">Risk-free retirement living?</span>
<span class="attribution"><a class="source" href="https://www.shutterstock.com/image-photo/surfer-nice-beach-1212137647">Rawpixel.com/Shutterstocl</a></span>
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</figure>
<p>In the past 25 years there has been a big transfer of investment and longevity risk from employers (who used to provide occupational pensions), from the state (who used to provide earnings-related state pensions) and from insurance companies (who typically used to sell annuities) on to people saving for retirement. </p>
<p>Managing these risks is now very important, especially as many working-age people may not realise just how much risk they are facing when it comes to ensuring financial security in retirement.</p><img src="https://counter.theconversation.com/content/206362/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Jonathan Cribb receives funding from the Economic and Social Research Council, abrdn Financial Fairness Trust and Nuffield Foundation. </span></em></p>Making sure you have enough set aside for a long retirement has become more difficult over the past 25 years.Jonathan Cribb, Senior Research Economist, Institute for Fiscal StudiesLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/1880422022-08-04T10:29:20Z2022-08-04T10:29:20ZUK interest rate rise: what the Bank of England’s historic hike means for your money<figure><img src="https://images.theconversation.com/files/477438/original/file-20220803-9397-e6swlj.jpg?ixlib=rb-1.1.0&rect=25%2C25%2C5725%2C3802&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">Households will feel the effect of rate rises as the Bank of England tries to slow inflation.</span> <span class="attribution"><a class="source" href="https://www.shutterstock.com/image-photo/closeup-view-woman-stacking-coins-table-1433398202">New Africa / Shutterstock</a></span></figcaption></figure><p>The Bank of England has raised its base rate by 0.5 percentage points, the largest single upward jump in 27 years. It takes the base rate to 1.75%, its highest level since 2008. This latest interest rate hike will affect personal finances and reflects the Bank’s efforts to control <a href="https://www.theguardian.com/business/2022/aug/03/inflation-will-soar-to-astronomical-levels-over-next-year-thinktank-warns">rampant inflation</a> amid the <a href="https://www.theguardian.com/money/2022/aug/01/cost-of-living-crisis-how-does-uk-compare-with-rest-of-europe">cost of living crisis</a> in the UK.</p>
<p>The government tasked the Bank of England with maintaining UK inflation at a stable level of <a href="https://www.bankofengland.co.uk/monetary-policy/inflation">2% a year</a>. At present, inflation is way above this target at <a href="https://www.ons.gov.uk/economy/inflationandpriceindices/datasets/consumerpriceindices">9.4%</a>, and it’s currently forecast to <a href="https://www.bankofengland.co.uk/monetary-policy-report/2022/august-2022#:%7E:text=push%20inflation%20to-,13%25,-In%20June%2C%20prices">reach 13%</a> by October. Among the <a href="https://www.bankofengland.co.uk/knowledgebank/will-inflation-in-the-uk-keep-rising#:%7E:text=with%20the%20past.-,Why%20is%20the%20rate%20of%20inflation%20in%20the%20UK%20so%20high%20now%3F,-There%20is%20more">main reasons</a> for this high inflation is the massive surge in the prices of global energy, grain and other key commodities. This has been caused by recent supply chain disruption and the Russian war on Ukraine. </p>
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Read more:
<a href="https://theconversation.com/five-essential-commodities-that-will-be-hit-by-war-in-ukraine-177845">Five essential commodities that will be hit by war in Ukraine</a>
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<p>These external factors are beyond the Bank of England’s control. But the Bank is concerned that high levels of inflation will become baked into the economy if domestic wages and prices spiral upwards to compensate for these global price rises. By raising the base rate, it aims to slow the UK economy, weakening workers’ wage bargaining power and so forcing inflation back down.</p>
<p>This isn’t going to happen overnight. It takes <a href="https://www.bankofengland.co.uk/-/media/boe/files/quarterly-bulletin/1999/the-transmission-mechanism-of-monetary-policy">one to two years</a> for the effects of base rate increases to work through the economy. But once this happens, the effects are painful. The Bank has forecast that unemployment will rise from <a href="https://www.ons.gov.uk/employmentandlabourmarket/peopleinwork/employmentandemployeetypes/datasets/labourmarketstatistics">3.8% today</a> to <a href="https://www.bankofengland.co.uk/monetary-policy-summary-and-minutes/2022/may-2022">5.5% next year</a>, implying that an extra 600,000 people will lose their jobs. And, if your wages and other income are lagging behind inflation, your standard of living is being squeezed.</p>
<p>The Bank of England base rate is an important benchmark used by banks to set the interest rates for all kinds of financial products. So, when it comes to personal finances, a base rate rise has a varied impact. Here are the main ways your money will be affected.</p>
<h2>Your savings</h2>
<p>In theory, the rise in the Bank of England base rate should be good news for savers with bank and building society accounts and government-backed <a href="https://www.nsandi.com/">National Savings & Investment</a> products. The rise should be passed on to your account’s interest rate, although this depends on the extent to which providers allow their savings rates to follow the rise in base rates, as well as how far rates actually rise.</p>
<p>Savers should look at the real return, which is the quoted interest rate less the inflation rate. As the chart below shows, easy-access savers last saw inflation-beating returns back in early 2008, before the global financial crisis took hold. Since then, real returns have been persistently negative. In effect, this means savers are paying for the privilege of keeping their money readily accessible.</p>
<h2>Bank of England base rate versus savings rates</h2>
<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/477440/original/file-20220803-23-l1bido.png?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="Line chart showing Bank of Englnd base rate changes and savings rates" src="https://images.theconversation.com/files/477440/original/file-20220803-23-l1bido.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/477440/original/file-20220803-23-l1bido.png?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=374&fit=crop&dpr=1 600w, https://images.theconversation.com/files/477440/original/file-20220803-23-l1bido.png?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=374&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/477440/original/file-20220803-23-l1bido.png?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=374&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/477440/original/file-20220803-23-l1bido.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=470&fit=crop&dpr=1 754w, https://images.theconversation.com/files/477440/original/file-20220803-23-l1bido.png?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=470&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/477440/original/file-20220803-23-l1bido.png?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=470&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
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<span class="caption">Bank of England base rate and real return on easy access savings account, November 2003 to June 2022.</span>
<span class="attribution"><span class="source">Author’s chart based on data from Bank of England, Office for National Statistics and selected print editions of Moneyfacts</span></span>
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<p>Back in November 2021, before this recent series of base rate rises, the best easy-access accounts were offering rates of around 0.60% to 0.70% a year, according to my research using <a href="https://www.moneyfactsgroup.co.uk/magazines-and-reports/moneyfacts-magazine/subscribe/">Moneyfacts</a> data. By June, these rates had risen to 1.55% but this has been outstripped by the rise in inflation and so savers’ real returns have fallen rather than improved.</p>
<p>Rates are higher – at more than 3% a year – if you’re prepared to lock your money away for two to five years. That could look appealing if you expect a fairly rapid fall in inflation back to the 2% target.</p>
<h2>Your pension</h2>
<p>When approaching retirement, you may use some or all of your pension savings to <a href="https://www.unbiased.co.uk/life/pensions-retirement/step-by-step-guide-to-buying-an-annuity">buy an annuity</a>. Although this is a product that pays a secure income for life, you must give up your savings to buy it and changing your mind later on is not an option. </p>
<p>The rising base rate is feeding through to improve annuity rates. For example, if you’re 65 years old, with an <a href="https://www.fca.org.uk/data/retirement-income-market-data-2020-21">average pot size of £68,000</a>, <a href="https://www.moneyfactsgroup.co.uk/magazines-and-reports/investment-life-pensions-moneyfacts-magazine/">Moneyfacts</a> data suggests you could have bought a fixed yearly income for life of £3,352 in November 2021. By June, that potential income increased by more than a fifth to £4,066.</p>
<h2>Your mortgage</h2>
<p>House prices have boomed for decades, especially since the 2008 global financial crisis. This has been fuelled by central bank <a href="https://www.bankofengland.co.uk/monetary-policy/quantitative-easing">quantitative easing</a> programmes, which are designed to drive down interest rates and cause asset prices to rise because more money is available for borrowing and investing.</p>
<p>Rising house prices have been a boon if you’re already a homeowner, but this has also made it increasingly difficult for new buyers to afford a home. The average house price was around <a href="https://www.ons.gov.uk/peoplepopulationandcommunity/housing/datasets/ratioofhousepricetoworkplacebasedearningslowerquartileandmedian">four times</a> average earnings at the start of this century, rising to seven times by 2007 and is now eight times earnings. This means newer buyers have to take on much larger mortgage debts than previous generations.</p>
<figure class="align-center ">
<img alt="Fish jumping from crowded fishbowl into a bigger empty fishbowl" src="https://images.theconversation.com/files/477441/original/file-20220803-13-y4jqjt.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/477441/original/file-20220803-13-y4jqjt.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=440&fit=crop&dpr=1 600w, https://images.theconversation.com/files/477441/original/file-20220803-13-y4jqjt.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=440&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/477441/original/file-20220803-13-y4jqjt.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=440&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/477441/original/file-20220803-13-y4jqjt.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=553&fit=crop&dpr=1 754w, https://images.theconversation.com/files/477441/original/file-20220803-13-y4jqjt.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=553&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/477441/original/file-20220803-13-y4jqjt.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=553&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px">
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<span class="caption">Rising house prices have made it more difficult for new buyers to get their own homes.</span>
<span class="attribution"><a class="source" href="https://www.shutterstock.com/image-photo/goldfish-moving-bigger-house-122745868">khz / Shutterstock</a></span>
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<p>Large mortgages were not a problem while interest rates were historically low, as they have been since 2008. But the rise in base rates is now storing up problems in this area. Around three-quarters of current mortgage borrowers are on a <a href="https://www.ukfinance.org.uk/news-and-insight/blogs/how-the-bank-rate-affects-mortgage-rates#:%7E:text=Currently%2C">fixed-rate deal</a> of two to five years. If that applies to you, you’re sheltered from the base rate rises for now, but you should prepare for a jump in your repayments when your fixed-rate deal comes to an end. For the 2 million borrowers with a standard variable rate or tracker mortgage, housing costs are already rising rapidly.</p>
<p>Another important consideration is whether rising mortgage costs will choke demand and cause house prices to fall. The <a href="https://www.halifax.co.uk/assets/pdf/june-2022-halifax-price-index.pdf">Halifax House Price Index</a> shows no sign of a slowdown yet, which it attributes to a persistent supply shortage and continuing demand from better-off households who accumulated savings during the pandemic. </p>
<p>On the other hand, another major UK house price tracker, the Nationwide House Price Index, is showing “tentative signs of a slowdown in activity”. This has yet to feed through to prices. But the building society’s chief economist expects the UK housing market to slow as inflation puts pressure on household budgets and as the Bank of England raises interest rates further. As he points out, this is “<a href="https://www.nationwidehousepriceindex.co.uk/reports/annual-house-price-growth-stays-in-double-digits-as-july-sees-twelfth-successive-monthly-increase">widely expected</a>” to happen.</p><img src="https://counter.theconversation.com/content/188042/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Jonquil Lowe does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>The latest on the UK base rate rise and how it might affect your financesJonquil Lowe, Senior Lecturer in Economics and Personal Finance, The Open UniversityLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/1382412020-05-26T12:16:57Z2020-05-26T12:16:57ZWant to do more for your favorite charity? Consider a planned gift<figure><img src="https://images.theconversation.com/files/336568/original/file-20200520-152288-2a7qg5.jpg?ixlib=rb-1.1.0&rect=830%2C75%2C2317%2C1486&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">Joan Kroc gave much to charity during her life and in her will after inheriting the McDonald's fortune.</span> <span class="attribution"><a class="source" href="http://www.apimages.com/metadata/Index/Watchf-AP-A-PA-USA-APHS469527-Kroc-Names-New-Padres-President/5e6f377c8a234cbab8c595019fdf9132/99/0">AP Photo/Bill Cramer</a></span></figcaption></figure><p>The coronavirus pandemic has led many Americans to <a href="https://www.theguardian.com/science/blog/2017/jul/25/we-fear-death-but-what-if-dying-isnt-as-bad-as-we-think">consider their own mortality</a> and <a href="https://abcnews.go.com/Health/coronavirus-leads-surge-wills-thinking-mortality/story?id=69874540">plan for the future</a>.</p>
<p>One sign of this trend: the number of people using <a href="https://www.cnbc.com/2020/03/25/coronavirus-pandemic-triggers-rush-by-americans-to-make-online-wills.html">will-writing websites</a> surged by as much as 200% in late March, when the vast majority of states ordered social distancing measures.</p>
<p>As a <a href="https://scholar.google.com/citations?hl=en&user=tu70lmIAAAAJ">scholar of philanthropy who used to raise money for nonprofits</a>, I see an opportunity even at this difficult moment. Few Americans consider leaving money to charity when they declare who should inherit their assets after they die. </p>
<p>At the same time, many nonprofits face a <a href="https://www.bostonglobe.com/2020/05/12/business/galas-postponed-or-going-virtual-nonprofits-see-big-drop-fund-raising-while-demand-services-rise/">dire situation</a> as a result of the pandemic. Demand for their services is growing while in many instances their revenue is plummeting. In the case of <a href="https://www.bostonglobe.com/2020/05/12/business/galas-postponed-or-going-virtual-nonprofits-see-big-drop-fund-raising-while-demand-services-rise/">shuttered museums, symphonies and theaters</a>, they are also missing out on money from ticket sales that they need to survive.</p>
<h2>Few wills</h2>
<p>Only <a href="https://theconversation.com/68-of-americans-do-not-have-a-will-137686">32% of Americans have a will</a>, according to recent estimates, down from <a href="https://www.caring.com/caregivers/estate-planning/wills-survey">42% a few years ago</a>. </p>
<p>But the share of the population planning to leave money to charity is far smaller: only an estimated <a href="https://www.slideshare.net/rnja8c/charitable-bequest-demographics-33283226">5% of Americans</a>. This is a tiny sliver of the people who support nonprofits in a given year. According to a recent Gallup poll, some <a href="https://news.gallup.com/poll/310880/percentage-americans-donating-charity-new-low.aspx">73% of Americans</a> made a charitable donation to a religious institution or another charity last year.</p>
<p>The most common way to make what is technically called a “<a href="https://www.forbes.com/sites/russalanprince/2016/07/05/what-is-planned-giving/#7018945548a9">planned gift</a>” is <a href="https://www.fidelitycharitable.org/guidance/philanthropy/what-are-bequests.html">a bequest</a> – a donation to a nonprofit noted in someone’s will. While the intention is expressed during the person’s lifetime, charities get the money or other assets after they’ve died.</p>
<p>Even though the numbers participating are small, bequest giving has quadrupled to nearly $40 billion annually over the past 40 years, according to the annual <a href="https://givingusa.org/giving-usa-2019-americans-gave-427-71-billion-to-charity-in-2018-amid-complex-year-for-charitable-giving/">Giving USA report</a>.</p>
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<p>That’s almost 10% of <a href="https://theconversation.com/american-giving-lost-some-ground-in-2018-amid-tax-changes-and-stock-market-losses-118892">all the money going to charity</a> each year. But I see plenty of room for growth.</p>
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<h2>Many ways to give</h2>
<p>Sometimes these donations <a href="https://www.nytimes.com/2018/05/06/nyregion/secretary-fortune-donates.html">are unexpected</a>. But many donors prefer to <a href="https://www.latimes.com/entertainment/arts/culture/la-et-cm-jerry-perenchio-lacma-michael-govan-news-conference-20141106-story.html">personally notify</a> the nonprofits they’ve selected. </p>
<p>It’s hard to get precise data on these gifts, because the IRS doesn’t collect it except from the estates of the wealthiest Americans.</p>
<p>There are other ways to leave money to charity after death besides bequest clauses in wills. All or part of an <a href="https://financial-dictionary.thefreedictionary.com/IRA">Individual Retirement Account</a>, or IRA, as well as 401(k)s and other employer-sponsored retirement plans can be left to charity. The same goes for <a href="https://www.forbes.com/sites/russalanprince/2016/07/05/what-is-planned-giving/#6b8c4a2648a9">many other kinds of assets</a>, including life insurance policies, trusts, real estate and tangible personal property, like artwork.</p>
<h2>A charitable opportunity</h2>
<p>My research shows that writing a will, especially when it calls for leaving money to a charity, actually <a href="https://givingusa.org/just-released-special-report-leaving-a-legacy-a-new-look-at-planned-giving-donors/">puts peoples’ minds at ease</a>. It’s a way people make meaning of their lives.</p>
<p>“I’ve been able to express my appreciation for the organization and my commitment to the cause beyond my time here,” is how one donor I’ll call Diane put it during our interview about her motivations for making a planned gift. </p>
<p>In a <a href="https://givingusa.org/just-released-special-report-leaving-a-legacy-a-new-look-at-planned-giving-donors/">national study of planned gift donors</a> last year, my research team and I found that the average age for writing a first will is 44 years old and that over half of the donors surveyed for the study established their first planned gift at the same time as their first will.</p>
<p>For those who make gifts, it’s not a difficult process. A total of 68% of the 862 donors we surveyed said making their planned gift was “very” or “somewhat easy.”</p>
<h2>Not just for the 1%</h2>
<p>Many people think that writing a will is only for the very rich, but really <a href="https://www.marketwatch.com/story/why-wills-arent-just-for-the-wealthy-2015-03-17">anyone with a family, home, or bank account should have one</a>. You don’t have to be very rich to make bequests. Some <a href="https://ssir.org/articles/entry/philanthropys_missing_trillions">middle class donors</a> write charitable gifts into their wills that exceed $100,000. </p>
<p>For many donors, planned giving enables them to make a larger gift after death than their finances would allow them to do during their life.</p>
<p>Based on my team’s research, we know that donors who make planned gifts are often long-time supporters, have worked or volunteered for the organization they’re supporting and believe in its mission. And because nearly 92% of the people we surveyed consulted an attorney when they wrote their will, it’s important that lawyers and financial planners at least raise the topic.</p>
<p>For nonprofits, estate gifts often come from those with long histories with the organization. On average, donors we surveyed had been supporting the organization that would receive their largest planned gift for 20 years.</p>
<p>The coronavirus pandemic and resulting financial crisis mean that <a href="https://www.marketwatch.com/story/why-coronavirus-could-devastate-charities-even-more-than-the-great-recession-did-2020-04-07">many people will have more trouble than usual giving to charity</a>. I believe that when anyone drafts or revises their wills, it’s important that they discuss how to support causes they care about after their death with their lawyers and loved ones.</p>
<p>[<em>Deep knowledge, daily.</em> <a href="https://theconversation.com/us/newsletters?utm_source=TCUS&utm_medium=inline-link&utm_campaign=newsletter-text&utm_content=deepknowledge">Sign up for The Conversation’s newsletter</a>.]</p><img src="https://counter.theconversation.com/content/138241/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Elizabeth J. Dale has received funding from The Giving USA Foundation for her planned giving research as well as the Bill & Melinda Gates Foundation via Indiana University and the Ford Foundation for other research on philanthropy. The views expressed in this essay are strictly my own and do not reflect policy stances of Seattle University or The Giving USA Foundation.</span></em></p>Far fewer Americans include plans for bequests to nonprofits in their wills than give to charity on a regular basis. The pandemic could be a good reason to change that.Elizabeth J. Dale, Assistant Professor of Nonprofit Leadership, Seattle UniversityLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/1274782019-11-25T16:22:13Z2019-11-25T16:22:13ZMany over-55s can’t cope with pension freedoms – it may now be time to scrap them<figure><img src="https://images.theconversation.com/files/303159/original/file-20191122-74588-qhv7kz.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">'Not such a great idea.'</span> <span class="attribution"><a class="source" href="https://www.shutterstock.com/image-photo/sad-pensive-unhappy-middle-aged-man-1550485877?src=1b4f0aac-b503-47bb-abc6-4dba68df72d0-1-61">Oleg Govnev</a></span></figcaption></figure><p>For decades, the UK pensions industry could have been described as sleepy: a lack of vim and vigour borne of long time-scales and limited innovation. Come April 2015, <a href="https://www.moneysavingexpert.com/savings/pension-freedom/">everything changed</a>. The UK government scrapped the system that all but forced retirees without final salary schemes to buy an annuity with the money they had saved in their pension plans. Instead, those reaching the age of 55 were suddenly gifted “pensions freedom” to invest, cash-in or annuitise their savings. </p>
<p>These reforms could equally, if less attractively, have been termed as “imposing pensions responsibility”. Overnight, UK retirees found themselves responsible for managing their own pensions wealth – a complex decision with profound long-term consequences. Getting it wrong could mean running out of money just when you need it for social care, or potentially dying with a full bank account, having missed out on experiences you could have affordably enjoyed.</p>
<p>In practice, people do not seem to be coping well with these responsibilities. It was <a href="https://www.mirror.co.uk/money/million-people-cashing-pensions-worth-13906539">reported</a> earlier in 2019 that since the reforms, around a million people had cashed out £23 billion in pensions savings – often harming their financial future in the process. And according to <a href="https://onlinelibrary.wiley.com/doi/10.1111/ecca.12326">research</a> that I have just co-published, the system that the government brought in to help advise retirees may actually be making things worse. </p>
<h2>What happened next</h2>
<p>Nobody saw these pensions freedoms reforms coming when they were introduced, including the pensions industry, regulators and consumer watchdogs. Myself and my co-reseacher Jenny Robinson, a behavioural economist at Irrational Insights, could find no evidence of pre-testing on whether the general public wanted control of their pensions, how they would behave or what factors might affect their choices. </p>
<p>The reforms were widely criticised, including by <a href="https://theconversation.com/danger-strikes-when-foolish-humans-are-left-in-charge-of-their-financial-futures-45262">experts</a> writing in <a href="https://theconversation.com/giving-people-extra-responsibility-for-pensions-is-a-disaster-in-the-making-65699">The Conversation</a>. Commentators correctly <a href="https://theconversation.com/the-governments-new-pension-service-has-one-fatal-flaw-37726">predicted</a> that <a href="https://www.ftadviser.com/pensions/2019/07/31/pension-freedom-withdrawals-hit-new-record/">the UK</a> would <a href="https://www.fca.org.uk/data/retirement-income-market-data">mirror</a> other countries <a href="https://theconversation.com/pension-shake-up-will-leave-some-high-and-dry-without-proper-guidance-24861">like the US</a>, where people given these choices <a href="https://faculty.chicagobooth.edu/richard.thaler/assets/files/NYT%20june%204%202011.pdf">tend to</a> buy fewer annuities than is economically optimal, and <a href="https://pdfs.semanticscholar.org/5b36/6b83ae75a6e2baff7fc0e2e9696d2d49a6df.pdf">instead choose</a> to cash out. </p>
<figure class="align-right zoomable">
<a href="https://images.theconversation.com/files/303160/original/file-20191122-74576-ogwsxv.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="" src="https://images.theconversation.com/files/303160/original/file-20191122-74576-ogwsxv.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=237&fit=clip" srcset="https://images.theconversation.com/files/303160/original/file-20191122-74576-ogwsxv.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=684&fit=crop&dpr=1 600w, https://images.theconversation.com/files/303160/original/file-20191122-74576-ogwsxv.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=684&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/303160/original/file-20191122-74576-ogwsxv.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=684&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/303160/original/file-20191122-74576-ogwsxv.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=860&fit=crop&dpr=1 754w, https://images.theconversation.com/files/303160/original/file-20191122-74576-ogwsxv.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=860&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/303160/original/file-20191122-74576-ogwsxv.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=860&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
<figcaption>
<span class="caption">‘Mmmm time-inconsistency.’</span>
<span class="attribution"><a class="source" href="https://www.shutterstock.com/image-photo/glass-jar-strawberry-jam-fresh-berries-662448370?src=c541cc79-5647-43e1-b4ef-fa32b40dfe68-1-16">Alter-Ego</a></span>
</figcaption>
</figure>
<p>A variety of reasons have been suggested for this. These include behavioural factors such as what are known as <a href="https://www.intelligenteconomist.com/time-inconsistency/">time-inconsistent preferences</a>, in which we essentially opt for jam for today. Many of us are also horrified by the prospect of exchanging a large sum of money for a series of small cheques. </p>
<p>Added to these are rational factors such as trivial monthly incomes from small pension pots and poor value for money, in a world where <a href="https://www.economicshelp.org/blog/848/economics/savings-ratio-uk/">savings are producing</a> much lower returns than they used to. </p>
<p>To its credit, HM Treasury was not totally blind to the possibility that people would need guidance on managing their pension wealth: as part of the reforms, it established a free-to-use pensions advice website called <a href="https://www.pensionwise.gov.uk/en">Pension Wise</a>. As it turns out, however, apparently sensible advice can have perverse consequences. </p>
<p>One of the Pension Wise recommendations is to consider how long your pension wealth needs to last. This seems logical, given that one of the main advantages of an annuity is that it guarantees an income until death. Jenny Robinson <a href="https://onlinelibrary.wiley.com/doi/10.1111/ecca.12326">conducted</a> an experiment on over 2,000 UK residents for her MSc behavioural science dissertation to see how they reacted to this advice in practice. </p>
<p>Her respondents matched the UK population in terms of education, gender, age and social class. By not concentrating on the 55-plus people who currently enjoy the UK’s pension freedoms, she was able to get an insight into how people will make decisions in future. Having said that, there was no significant difference in the choices of the 55-plus age group in the experiment and the sample group as a whole. </p>
<p>Jenny, who also provided some input for this article, asked the respondents to choose between an annuity and cashing out their pension – it made sense to give them a binary choice, since although there are more options in real life, it would be impossible to account for all of them. Some respondents were asked to consider their life expectancy immediately prior to making their choice. To our surprise, this made people <em>more likely</em> to cash out. </p>
<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/303161/original/file-20191122-74562-1sfv1v4.png?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="" src="https://images.theconversation.com/files/303161/original/file-20191122-74562-1sfv1v4.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/303161/original/file-20191122-74562-1sfv1v4.png?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=366&fit=crop&dpr=1 600w, https://images.theconversation.com/files/303161/original/file-20191122-74562-1sfv1v4.png?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=366&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/303161/original/file-20191122-74562-1sfv1v4.png?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=366&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/303161/original/file-20191122-74562-1sfv1v4.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=459&fit=crop&dpr=1 754w, https://images.theconversation.com/files/303161/original/file-20191122-74562-1sfv1v4.png?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=459&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/303161/original/file-20191122-74562-1sfv1v4.png?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=459&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
<figcaption>
<span class="caption">The government pension advice agency.</span>
<span class="attribution"><a class="source" href="https://www.pensionwise.gov.uk/en">Pension Wise</a></span>
</figcaption>
</figure>
<p>It didn’t help that an unregulated “pensions advice” industry sprang up after the reforms. It was cold-calling customers and arguably exploiting their lack of experience with such decisions. In 2018, as many as 180 people <a href="https://www.fca.org.uk/news/press-releases/5m-pension-savers-could-put-retirement-savings-risk-scammers">reported losses</a> averaging £82,000 to Action Fraud. At the beginning of 2019, this cold-calling <a href="https://www.bbc.co.uk/news/business-46799038">was banned</a> by the Financial Conduct Authority (FCA). </p>
<p>There are <a href="https://www.moneyadviceservice.org.uk/en/articles/how-to-spot-a-pension-scam">plenty more scams</a> in the pipeline, however. These include inappropriate exotic investments, fraudulent transfers and <a href="https://www.moneysavingexpert.com/savings/pension-liberation/">early access to savings</a> – all accompanied with hefty fees, and often tax penalties. It has been <a href="https://www.thetimes.co.uk/article/pension-scams-cost-4bn-k6rh6jmfc">reported that</a> up to 100,000 people with final salary schemes have been encouraged to cash out or into high-risk investments, potentially costing them £4 billion.</p>
<h2>An open goal</h2>
<p><a href="https://www.fca.org.uk/news/press-releases/5m-pension-savers-could-put-retirement-savings-risk-scammers">Recent research</a> by the FCA and The Pensions Regulator suggests, rather strangely, that the people most at risk from scams are not the least educated, but those with a university degree. They are 40% more likely to accept free pension advice and 21% more likely to cash out as a result. Clearly, the state cannot assume that education and knowledge will protect against conniving scammers.</p>
<p>Nor is good financial advice necessarily going to protect people from making poor pension decisions. Recent <a href="https://www.ftadviser.com/pensions/2019/03/26/majority-of-savers-access-pensions-without-advice/">research</a> by Canada Life showed that over two-thirds of customers who have accessed their pensions since 2015 haven’t taken any independent financial advice. The same proportion also failed to shop around before buying either an annuity or a drawdown product from their pension provider.</p>
<p>It is clear that pensions freedoms have created vast opportunities for customer detriment. Yet so far during the UK election, none of the parties have had much to say on this subject: most discussion on pensions has been around <a href="https://inews.co.uk/opinion/comment/state-pensions-pensioners-general-election-2019-manifesto-policies-parties-explained-1317877">protecting</a> the state pension age and compensating <a href="https://news.google.com/articles/CBMiMWh0dHBzOi8vd3d3LmJiYy5jby51ay9uZXdzL2VsZWN0aW9uLTIwMTktNTA1MzQxMTjSATVodHRwczovL3d3dy5iYmMuY28udWsvbmV3cy9hbXAvZWxlY3Rpb24tMjAxOS01MDUzNDExOA?hl=en-GB&gl=GB&ceid=GB%3Aen">women who</a> lost out on state pension payouts when the retirement age was raised. </p>
<p>On pension freedoms, there is an urgent need for state intervention to address fraud, to improve customer take up of advice and to find behaviourally informed ways to help people navigate the choices they are offered. Or else, it may be time to roll back on pensions freedom altogether.</p><img src="https://counter.theconversation.com/content/127478/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>David Comerford does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>The system brought in by the government to advise retirees since the 2015 reforms may actually be making things worse.David Comerford, Program Director, MSc Behavioural Science, University of StirlingLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/656992016-10-05T15:13:26Z2016-10-05T15:13:26ZGiving people extra responsibility for pensions is a disaster in the making<figure><img src="https://images.theconversation.com/files/138448/original/image-20160920-11117-19pa5a5.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">Ready for a rainy day?</span> <span class="attribution"><a class="source" href="http://www.shutterstock.com/pic-107588384/stock-photo-powerful-tornado-destroying-property-with-lightning-in-the-background.html?src=mO-7uKBDIKiNyux8AE-Epw-1-1">solarseven</a></span></figcaption></figure><p>Even the Bank of England’s chief economist, Andy Haldane, <a href="https://www.ft.com/content/724cb536-1d4b-11e6-a7bc-ee846770ec15">admits to</a> “not being able to make the remotest sense of pensions”. So what chance has everybody else? Many people <a href="https://www.gov.uk/government/publications/attitudes-to-pensions-the-2012-survey-rr813">find</a> pensions and saving for retirement confusing and worrying. A substantial minority <a href="https://fullfact.org/economy/counting-cost-poor-literacy-and-numeracy-skills/">have</a> such low levels of financial capability, adult numeracy and literacy as to seriously affect their life chances.</p>
<p>Yet this is a time when 5.4m UK workers <a href="https://www.nao.org.uk/wp-content/uploads/2015/11/Automatic-enrolment-to-workplace-pensions.pdf">have been</a> enrolled into <a href="https://www.gov.uk/workplace-pensions/about-workplace-pensions">new workplace pensions</a> in 2012-15 thanks to government pension policy, with another 3.6m due to be enrolled by 2018. These are new savers who did not previously have a pension provision. It is <a href="https://www.nao.org.uk/wp-content/uploads/2015/11/Automatic-enrolment-to-workplace-pensions.pdf">expected to</a> result in an extra £14 billion to £16bn in savings per year by 2019-20, which will help offset the <a href="http://www.cityam.com/243183/this-is-why-the-uk-is-facing-a-time-bomb-of-retirement-woes">problem that</a> people in the UK are saving far too little for retirement. </p>
<p>But most of these savings are in <a href="http://www.nowpensions.com/defined-contribution/">defined contribution</a> private pension “pots”. Unlike with final salary schemes, there is no guaranteed sum at the end. It means individuals have to monitor and assess their pension’s performance and make investment decisions at retirement (if not before). </p>
<p>The old system where people used their lump sums to buy an annuity on retirement to secure an annual income is meanwhile in decline. Annuity rates have been <a href="http://www.bbc.co.uk/news/business-36749825">falling for years</a> because people are living longer, and this has been exacerbated by the vote for Brexit. The decline has made it more and more expensive for retirees to buy annuities that pay the same regular income. </p>
<p>Following the pension freedoms <a href="http://www.bbc.co.uk/news/business-32087038">introduced</a> in 2015, people may now be tempted to avoid annuities and either take their whole pension pot in cash at retirement or leave it invested in their pension fund and dip in as necessary. Again, this makes it more complicated to make the most of what they have. </p>
<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/139896/original/image-20160930-9908-1dfq1q4.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="" src="https://images.theconversation.com/files/139896/original/image-20160930-9908-1dfq1q4.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/139896/original/image-20160930-9908-1dfq1q4.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=400&fit=crop&dpr=1 600w, https://images.theconversation.com/files/139896/original/image-20160930-9908-1dfq1q4.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=400&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/139896/original/image-20160930-9908-1dfq1q4.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=400&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/139896/original/image-20160930-9908-1dfq1q4.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=503&fit=crop&dpr=1 754w, https://images.theconversation.com/files/139896/original/image-20160930-9908-1dfq1q4.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=503&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/139896/original/image-20160930-9908-1dfq1q4.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=503&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
<figcaption>
<span class="caption">Look after the pennies …</span>
<span class="attribution"><a class="source" href="http://www.shutterstock.com/pic-316713254/stock-photo-savings-money-annuity-insurance-retirement-and-people-concept-close-up-of-senior-woman-hand-putting-coin-into-piggy-bank.html?src=NB6KO22h0w4FlVBA9d-D-w-1-0">Syda Productions</a></span>
</figcaption>
</figure>
<h2>Help at hand?</h2>
<p>The upshot is that access to expert financial advice has become more important for ensuring good retirement outcomes. A <a href="http://www.fsa.gov.uk/Pages/About/What/rdr/index.shtml">package of</a> reforms in 2012 were designed to improve advice by enabling “more consumers to have their needs and wants addressed”. This removed the potential for biased advisers by banning commission payments and imposing fees for advice. It also increased the qualifications required of financial advisers as part of a drive to improve professionalism in the industry.</p>
<p>The downside has been more complex regulation and higher costs for advisers. Individuals are now <a href="http://www.cass.city.ac.uk/__data/assets/pdf_file/0016/202336/The-impact-of-RDR-Cass-version.pdf">estimated to</a> need upwards of £61,000 to £100,000 of investible assets to be a profitable client for financial advisers. As a result, advisers <a href="http://www.cassknowledge.com/sites/default/files/article-attachments/the-guidance-gap.pdf">are charging</a> an average of £150 per hour in fees and many people appear unwilling to pay.</p>
<p>To offer an alternative, the UK government <a href="http://www.bbc.co.uk/news/business-12960667">created</a> a free national financial “guidance” scheme in 2011. Guidance falls short of regulated financial advice because it cannot involve giving an individual recommendation, but this difference <a href="https://www.fs-cp.org.uk/sites/default/files/advice-gap.pdf">has caused</a> confusion. The trouble is that no one is liable for bad guidance in the way that they could be for bad advice. People can make pension decisions not appreciating this distinction. </p>
<p>The UK’s main provider of financial guidance, the Money Advice Service, has not helped by <a href="https://www.moneyadviceservice.org.uk/en">claiming</a> to provide “free and impartial advice”. (The service was <a href="http://www.bbc.co.uk/news/business-35820752">recently</a> condemned as unfit for purpose and is being replaced.)</p>
<p>People can also get free pension guidance on the new pension freedoms from <a href="https://www.citizensadvice.org.uk">Citizens Advice</a> and the <a href="http://www.pensionsadvisoryservice.org.uk">Pensions Advisory Service</a>. But many people <a href="https://www.citizensadvice.org.uk/Global/CitizensAdvice/Families%20Publications/LifeafterpensionchoicesPDF.pdf">still access</a> their pension pots at retirement <a href="https://www.blackrock.com/investing/literature/whitepaper/uk-pension-freedoms-unfinished-business.pdf">without such guidance</a>. When it comes to deciding what to do with the money, many <a href="https://www.citizensadvice.org.uk/Global/CitizensAdvice/Families%20Publications/LifeafterpensionchoicesPDF.pdf">have simply</a> deposited it in a bank account. </p>
<p>The government’s <a href="https://www.gov.uk/government/consultations/introducing-a-pensions-advice-allowance/introducing-a-pensions-advice-allowance-consultation">latest proposal</a> is to allow individuals to take up to £500 out of their pension pot to pay for advice. This is helpful but may only pay for two or three hours, so it’s of limited use (even assuming it persuades a good number of people to buy advice rather than just raiding their pension pot). </p>
<p>The regulator is <a href="https://www.fca.org.uk/publication/corporate/famr-final-report.pdf">also encouraging</a> the financial advice sector to innovate by providing more “robo-advice” – cheap and accessible online advice built on algorithms, among other things. To date, progress has been limited, but <a href="http://www.professionaladviser.com/professional-adviser/news/2471708/eight-large-robo-advisers-on-the-way-fca-says?utm_medium=email&utm_campaign=IFA.Update_RL.EU.A.U&utm_source=PA.DCM.Editors_Updateshttp://example.com/">it now seems</a> as if a number of advisers may now be entering the robo-advice market. </p>
<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/139897/original/image-20160930-9899-mw0w5d.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="" src="https://images.theconversation.com/files/139897/original/image-20160930-9899-mw0w5d.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/139897/original/image-20160930-9899-mw0w5d.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=400&fit=crop&dpr=1 600w, https://images.theconversation.com/files/139897/original/image-20160930-9899-mw0w5d.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=400&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/139897/original/image-20160930-9899-mw0w5d.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=400&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/139897/original/image-20160930-9899-mw0w5d.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=503&fit=crop&dpr=1 754w, https://images.theconversation.com/files/139897/original/image-20160930-9899-mw0w5d.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=503&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/139897/original/image-20160930-9899-mw0w5d.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=503&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
<figcaption>
<span class="caption">‘Oh boy.’</span>
<span class="attribution"><a class="source" href="http://www.shutterstock.com/pic-178582475/stock-photo-anxious-elderly-senior-couple-worring-about-financial-security-at-consultation.html?src=ZT0tlcsHXeNYUGYOiGpMHg-1-12">Robert Kneschke</a></span>
</figcaption>
</figure>
<h2>The road ahead</h2>
<p>When people are not saving enough for retirement and the ultimate responsibility for financial outcomes is increasingly with individual savers, it is incumbent upon the government to ensure people can cope with the demands placed upon them. At present, its policies are not accomplishing that. </p>
<p>Since the 2008 financial crisis, many people have had a lack of trust in financial services, making some unwilling to invest in financial products, at a time when rising life expectancy means everyone needs their money to last for longer. Put together, the prospects for pension retirement outcomes are becoming more and more worrying.</p>
<p>Haldane <a href="https://www.theguardian.com/money/2016/aug/28/property-is-better-bet-than-a-pension-says-bank-of-england-economist">recently said</a> it may be better to invest in property than pensions, arguing that property prices were likely to keep rising unless we finally get to grips with the shortage of new housing. This is not financial advice, of course, but for some it may be the nearest many people are going to get unless robo-advice proves to be successful in widening access to affordable financial advice. </p>
<p>Failing that, the government risks creating a generation of older people who cannot afford to look after themselves. If that happens, we will all pay the price.</p><img src="https://counter.theconversation.com/content/65699/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Patrick Ring does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>Financial reforms have given us a greater role in saving for retirement. Alas we’re not very good at it.Patrick Ring, Senior Lecturer in Financial Services, Glasgow Caledonian UniversityLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/441842015-07-08T20:05:35Z2015-07-08T20:05:35ZLiving longer means it’s time Australians embraced annuities<figure><img src="https://images.theconversation.com/files/87265/original/image-20150703-30213-mbv9rw.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">Retirees don't always succeed in ensuring their retirement income lasts the distance.</span> <span class="attribution"><span class="source">Image sourced from Shutterstock.com</span></span></figcaption></figure><p>Few people are likely to be interested in buying an expensive financial product which offers little return, particularly when that return is based on their life expectancy. But annuities, which provide a series of regular payments until the death of the annuitant in return for a lump sum investment, deserve closer attention. </p>
<p>Despite the benefits of annuitisation, there is considerable evidence of <a href="http://www.limra.com/Secure_Retirement_Institute/News_Center/Retirement_Industry_Report/Annuities_-_Solving_the_Annuity_Aversion_Puzzle.aspx">annuity aversion</a> among individuals. This has led to what economists call the “annuity puzzle”. It’s like this: let’s agree there are some benefits, we won’t buy it anyway.</p>
<h2>The good…</h2>
<p>Life annuities provide longevity insurance, which is another way of saying they guarantee the annuitant an income until death. Managing longevity risk is an integral part of any retirement system. The recent <a href="http://fsi.gov.au">Financial System Inquiry</a> (FSI) regards longevity protection as a “major weakness” of Australia’s retirement income system. </p>
<p>The most popular retirement product, Account-Based Pensions (ABPs), provides flexibility and liquidity but leaves individuals with longevity, inflation and investment risks. The FSI recommends that superannuation trustees pre-select a comprehensive income product for retirement (CIPR) that has minimum features determined by the government. This product will help members receive a regular income and manage longevity risk. This is the main job of annuities.</p>
<p>One important feature of annuities is the return of capital (ROC). Investors are guaranteed up to 100% return of capital in the first 15 years of annuity purchase. If the investor dies in this period and does not have a joint owner or nominated person to receive payments when they die, a lump sum payment is made to her estate.</p>
<h2>The Bad…</h2>
<p>The idea of losing liquidity by locking up capital in annuities does not make the product very appealing. Also, the lower rate of return compared to investing directly in financial markets or alternative financial products is a reason why Australians shun annuities.</p>
<p>Annuitising is also seen as an irreversible choice in most cases and therefore investors are careful when to commit to it. This decision is delayed further when individuals have bequest or capital preservation needs, making full annuitisation an unlikely choice for most retirees. Today’s annuity with ROC to some extent caters for some of these concerns, but some of these drawbacks continue to loom large in the minds of investors.</p>
<h2>An alternative</h2>
<p>Let’s consider deferred annuities instead. A deferred annuity is a financial security for which the annuitant makes a premium payment to the insurer. In return, the insurer agrees to make regular income payments to the insured for a period of time. However, unlike regular annuities, the first payment is deferred until an agreed future date, i.e. the deferred annuity does not make any payments until after the deferred period is passed. </p>
<p>They are cheaper compared to regular annuities, yet provide the necessary longevity insurance. Deferred Life Annuities (DLAs) continue payments until the death of the annuitant. DLAs have been acknowledged in <a href="http://www.asx.com.au/asxpdf/20141028/pdf/42t7k89h51ntbj.pdf">14 submissions to the Financial System Inquiry</a> and received widespread support from industry bodies and associations encouraging its uptake. Legislative barriers, however, prevent the development of such a product in Australia. </p>
<p>The major risk to the annuitant purchasing deferred annuities is that she may not survive the deferred period, forfeiting her annuity premium. The Return on Capital concept could be employed to help overcome this. There is also a degree of counter-party risk involved since the life company might become insolvent before retirees’ income payouts begin.</p>
<p>What if we didn’t need life insurance companies to provide this longevity insurance? Could the big superannuation funds provide the income retirees need? They certainly could, by taking some lessons from the deferred annuities concept to build a Group Self-Deferred Annuity (GSDA). A certain percentage or amount of retiree’s wealth (depending on size of balance at retirement) goes to the superannuation fund’s “deferred investment pool” at retirement. This serves as premium for the deferred annuity. The retiree still holds liquidity and controls remaining wealth and has opportunity for higher consumption even before the annuity payments begin. Remaining wealth may be subject to account based pension regulations ensuring minimum drawdowns.</p>
<p>According to such a structure, the annuity begins to pay out at age 80 or 85 years and the retiree’s income level will be a function of the premium invested, investment performance and mortality assumptions. With this approach, superannuation funds would be able to provide the much needed longevity insurance without resorting to complex products outside of superannuation. The “deferred investment pool” would undoubtedly require meticulous management as it would serve retirees beyond the deferred age. </p>
<p>If the retiree died before reaching the income payment stage, a discounted amount of her premium may be returned to her estate. The upside to surviving the deferral period is that the retiree may receive high mortality credits; additional return above the risk-free rate of return on the annuity income. Mortality credits stem from the redistribution of pooled wealth among surviving participants from retirees who die in the payment period. </p>
<p>While we seek to have a comprehensive income product in retirement, there are several starting points. A Group Self-Deferred Annuity is one option.</p><img src="https://counter.theconversation.com/content/44184/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Osei K. Wiafe does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>Annuities in their current form are largely unpopular, but with a bit of tweaking they could provide the retirement income fix Australia needs.Osei K. Wiafe, Research Fellow, Griffith Centre for Personal Finance and Superannuation (GCPFS), Griffith UniversityLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/292742014-07-16T20:20:57Z2014-07-16T20:20:57ZTurning super into income: inquiry opens retirement funding debate<figure><img src="https://images.theconversation.com/files/53972/original/5mry7k34-1405490070.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">The focus is shifting to how Australians access their super to fund retirement.</span> <span class="attribution"><span class="source">Wendy House/Flickr</span>, <a class="license" href="http://creativecommons.org/licenses/by-nc-nd/4.0/">CC BY-NC-ND</a></span></figcaption></figure><p>A good proportion of the Financial System Inquiry’s 460-page <a href="http://fsi.gov.au/files/2014/07/FSI_Report_Final_Reduced20140715.pdf">interim report</a> is dedicated to a discussion of superannuation and, in particular, to making the financial system better at facilitating the conversion of super into retirement income.</p>
<p>Currently, <a href="http://www.cepar.edu.au/media/129955/cepar_submission_to_the_financial_system_inquiry_-__final_final.pdf">the system does poorly</a>. It does not meet the risk management needs of retirees. They have few options if they want a stable income after retirement that is insured against longevity, investment and inflation risk.</p>
<p>Indeed, existing rules impede the development of such products. It may make sense in principle for a retiree to insure against outliving her savings by buying a “deferred annuity” consisting of an income stream that only starts paying out in 20 years’ time. But this would not be a wise move if (as is currently the case) the Age Pension means test deems that she is receiving that income in the intervening 20 years, and lowers her interim pension as a result.</p>
<p>The inquiry correctly identifies these issues as part of a wider problem of policy inconsistency: on the one hand, tax-advantaged retirement savings and default fund and portfolio allocations are mandated because we recognise we are subject to under-saving and behavioural biases. The majority never have to interact actively with superannuation during their working lives. On the other hand, retirement income decisions and risks are left entirely with individuals at the moment of retirement.</p>
<h2>Four options to tackle the problem</h2>
<p>The report puts forward four options, some of which are expected to become solid recommendations when the inquiry submits its final report in November 2014. These range from the full flexibility but limited risk management of the status quo (where individuals use super savings as they see fit, with some improvement in financial information, advice and education) to the limited flexibility but full risk management of compulsion (where some savings must be used to buy a longevity-protected product).</p>
<p>In between these extremes are two other options. The inquiry flags the possibility of incentivising longevity-protected products via tax or the Age Pension means test. But benefits from super are already tax-advantaged so incentivising longevity-protected products may require raising taxes on other income streams and lump sums.</p>
<p>This could tie in with addressing another concern noted by the inquiry: that the tax arrangements within the superannuation system are being used for estate planning rather than for providing retirement incomes. Super taxes may be an area that the government’s proposed tax review will also look at.</p>
<p>Finally, the inquiry opens the door to a full discussion of instituting a default for decumulation of super. A single default would not suit everyone and there are fiduciary concerns about automatically committing individuals to a given decumulation product, but an opt-out would be available and elements tailored to individual circumstances could be included. </p>
<p>Also only a proportion of savings above a certain threshold may be subject to the longevity-protected product default. These can guide those who are less engaged and offer flexibility to those wanting to make their own decision.</p>
<p>We know from <a href="http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1943599">research</a> that defaults have a strong behavioural effect – often more so than financial incentives. A recent online <a href="http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2409519">experiment</a>, led by the Centre of Excellence in Population Ageing Research, showed that in a decision to allocate assets between an account-based pension and an immediate annuity individuals were most likely to choose the default (see figure).</p>
<figure class="align-center ">
<img alt="" src="https://images.theconversation.com/files/53960/original/hmr5qycx-1405488087.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/53960/original/hmr5qycx-1405488087.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=437&fit=crop&dpr=1 600w, https://images.theconversation.com/files/53960/original/hmr5qycx-1405488087.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=437&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/53960/original/hmr5qycx-1405488087.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=437&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/53960/original/hmr5qycx-1405488087.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=550&fit=crop&dpr=1 754w, https://images.theconversation.com/files/53960/original/hmr5qycx-1405488087.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=550&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/53960/original/hmr5qycx-1405488087.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=550&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px">
<figcaption>
<span class="caption">Proportion of assets taken as an annuity with different defaults.</span>
<span class="attribution"><span class="source">Bateman, H, Eckert, C, Iskhakov, F, Louviere, J, Satchell, S and Thorp, S 2013, ‘Default and 1/N Heuristics in Annuity Choice’, School of Risk and Actuarial Studies Working Paper 2014/1, UNSW</span></span>
</figcaption>
</figure>
<p>Such products, perhaps combined with a tendering process (seen in countries such as Chile and Singapore) for the most competitively priced, may yet provide value for money with the right mix of flexibility and risk management, regardless of a person’s level of financial capacity, engagement or superannuation balance.</p><img src="https://counter.theconversation.com/content/29274/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Rafal Chomik works for the ARC Centre of Excellence in Population Ageing Research which receives funding from the Australian Research Council.</span></em></p><p class="fine-print"><em><span>Hazel Bateman receives funding from the Australian Research Council Discovery Grant Scheme, DP1093812. </span></em></p>A good proportion of the Financial System Inquiry’s 460-page interim report is dedicated to a discussion of superannuation and, in particular, to making the financial system better at facilitating the…Rafal Chomik, Senior Research Fellow, ARC Centre of Excellence in Population Ageing Research, UNSW, UNSW SydneyHazel Bateman, Associate Head of School, UNSW SydneyLicensed as Creative Commons – attribution, no derivatives.