Can you afford to live to 100?
When Otto von Bismarck launched the first state pension in Europe in the 1880s, only 1 per cent of the German population lived to collect it. Qualification for payment was carefully set at 70; the founder of the world’s pioneering welfare state had done his actuarial sums.
Today, many pensioners can expect to live for decades longer. The number of people reaching the age of 100 has quadrupled in the past 30 years and is likely to quadruple again by 2035. Increasing numbers of 100th birthday celebrations means the government has expanded the team sending telegrams from the Queen to seven employees.
It will be considerably harder to resolve the complex financial challenges that rising longevity presents. Only last week, the government announced it would accelerate the planned increase in the state pension age to 68 for millions of people born between 1970 and 1978 — a move projected to save £74bn. Its shrunken parliamentary majority can partly be blamed on the uproar over a “ dementia tax” to fund the rising cost of social care. The policy has been dropped — but the problem has not gone away.
Unless radical changes are made, it is almost certain that most people will not be able to save enough to fund several decades of retirement as we know it. But the concept of retirement is changing fast and our long-term financial plans must adapt accordingly.
Working for longer can reduce the “longevity risk” of our pensions and investments. Younger workers should consider saving a higher proportion of their incomes. But good financial planning also involves flexibility. The risk of running out of money must be weighed against dying with too much and incurring large inheritance tax bills.
When it comes to selecting financial products that can help us achieve this balance, innovation has not kept pace with rising life expectancy. Rather than wait for what the finance industry, regulators and politicians come up with, here is our guide to assessing your finances in later life:
Planning to live for longer
A child born in the developed world today has a more than 50 per cent chance of living to be over 105, say Andrew Scott and Lynda Gratton, professors at London Business School and authors of The 100 Year Life: Living and Working in an Age of Longevity.
Those aged 30 today have a 50 per cent chance of living to more than 100. At 50, you have even chances of reaching the age of 95. At 60, you have a 50 per cent chance of living to 90 or longer. Yet the financial plans of many individuals will not reflect these averages.
“You have to watch longevity risk,” says Chris Derbyshire, chief investment officer at Seven Investment Management. Planning for his own retirement, the 50-year-old came up with a financial model to gauge how his investments would perform over time. He initially assumed an “end point” of 85 years — until he completed a free online life expectancy test.
“You put in your race, income, health, the amount you drink and mine came back with an answer of 95,” he said. “This had a big impact on my model.” Faced with a potential investment window of 45 years, he then examined the impact of delaying the moment at which he started taking an income from his investments.
“I’ve probably got 10-15 years of compounding before I hit retirement and have to begin spending the money,” he says. “But if you can live relatively frugally around retirement, that makes a big difference to the outcomes as compounding works best when your pot is large.”
These kinds of mathematical equations are complicated by how long we might stay healthy. Public Health England says boys born between 2013 and 2015 have an average “healthy life expectancy” of just over 63 years, and can then expect to spend an average 16 years in poor health. Girls will on average be healthy until just over 64 years, and then spend 16.1 years in poor health.
The average “life expectancy gap” between the highest and lowest earners in the UK is nine years. However, the gap in the “healthy life expectancy” is 19 years. So while the wealthiest can expect to live for longer, many of those extra years may require expensive social or residential care.
Pension freedoms introduced in 2015 have increased worries that people will run out of money in old age. The number of people opting to keep their funds in drawdown has overtaken those choosing to buy guaranteed income via an annuity. Now that people can access pension savings from the age of 55, there are fears that retirement funds could be spent too early.
Since April 2015, the Financial Conduct Authority says 1m pension pots have been accessed, with 53 per cent fully cashed in. Current industry advice is that no more than 4 per cent a year should be taken as income.
The over-85 age group is now the fastest growing segment of the UK population, prompting the FCA to prepare a strategy on the ageing population. The watchdog stressed the importance of “deepening our understanding about how markets work for older consumers”. One recommendation was that the government could introduce a mid-retirement financial health check to prompt people at 75 to reconsider their financial position and plan for the remainder of their lives.
Prof Scott says we cannot afford to take our pensions at the age we currently do. As we are ageing more slowly, he says we should factor in being able to work and pay into a pension for longer. He predicts those currently aged 45 will probably work until 75, and that 20-year-olds will probably work until they are 80.
Ideally, we should opt for a series of careers with breaks between them for mid- and late-life training. We should all plan to fund our housing and think about paying for “extreme old-age care”, he says, adding that many of the financial products currently on the market are not up to the job.
While annuities guarantee a fixed or inflation-proofed income, rates are at all-time lows. Once taken, annuity rates will not increase when interest rates rise. This has encouraged some people reaching retirement age to opt for drawdown, with the intention of buying an annuity later.
A level annuity for a healthy 65-year-old would currently provide an annual income of £5,200 per £100,000 of pension pot. Assuming inflation of 2 per cent, to get it all back you would have to live until the age of 88, according to Aviva.
However, those who defer taking an annuity until they are 75 would currently earn about £8,000 a year for each £100,000 saved.
Despite rising longevity, the average age at which an annuity is purchased is 62 — the same as it was at the turn of the century.
Deferring when the state pension is taken can also make a difference. Those claiming the full state pension now will receive £159.55 per week but if they do not take it for a year, this is increased by 5.8 per cent or £479 a year. Prof John Kay argues that for those with other sources of income, deferring the benefit will boost your payments — assuming you survive long enough to receive them.
A longer working life will give us longer to save for pensions and less time to spend our retirement savings. Current industry advice is that when we start paying into a pension scheme we should halve our age and pay that percentage of our gross salary into our pension. Including the employer’s contributions, this amounts to 20 per cent of income at the age of 40, rising to 25 per cent at 50.
But as workers age, more of them become reliant on self-employment, meaning they lose out on valuable employers’ contributions.
“The lack of retirement provision among the self-employed is reaching crisis levels,” said John Lawson, head of policy and corporate benefits at Aviva.
The number of self-employed people aged 65 and over has more than doubled in the past five years. By the age of 70, almost 60 per cent of those in work are self-employed. The age of both part-time and full-time self-employed workers has risen disproportionately to the population as a whole over the past 10 years.
The power of property
People’s houses are often their biggest assets going into retirement, with more than 75 per cent of over-65s owning their homes, according to the English Housing Survey.
The election row over the proposed “dementia tax” showed that politicians are alert to the vast amounts of wealth tied up in property. The idea of leaving your home to your children may soon become history if equity release becomes a mainstream way of maintaining a standard of living in retirement.
Also known as lifetime mortgages, these products allow homeowners aged 55 and over to unlock equity in their homes and “roll up” the interest.
Baroness Altmann, a former pensions minister, says a national equity release scheme with low interest rates would be of real help to millions facing retirement, as well as encouraging people to downsize to release equity from their homes.
While annuities have suffered from low interest rates, the appeal of equity release has been boosted. The cost of a policy can be frozen at the outset at around 4 per cent a year. The interest is rolled up, which means someone taking out £50,000 from the value of their home would owe £109,555 after 20 years if they made no voluntary repayments. The loan is repaid when the property is eventually sold.
These products have had a bad reputation in the past, but the Safe Homes Income Plans standard operated by the Equity Release Council ensures customers are guaranteed that their estate will never have to pay more than the value of the home. All current providers have to subscribe to these rules.
Some older homeowners are using equity release to gift money to their children or help grandchildren on to the housing ladder and at the same time reduce their inheritance tax bills.
Aviva also offers an Inheritance Protection Guarantee that allows customers to safeguard a percentage of their home’s value for inheritance purposes.
Baroness Altmann would like to see further innovation when it comes to saving to fund social care in later life, whether through Isas or pensions.
“The idea should be that you don’t want to spend it all in your 60s and 70s, but keep money for yourself into your 80s and 90s,” she said. “The government needs to incentivise people, for example by making pension withdrawals tax-free if used for care, or allowing Care Isas to pass on free of inheritance tax if not used to pay for social care.”
The institution of marriage has also been affected by rising longevity. According to Prof Scott, divorce rates are rising most rapidly in the over-80s age group. This is from a low base figure, but it is also a sign that some people who have separated but not divorced want to tidy up their estates.
The growth in cohabitation among pensioners is a concern because living together outside marriage or a civil partnership means that couples cannot leave their partner their assets without incurring inheritance tax. Roughly one-third of 1m people over 65 are cohabiting. This number is growing steadily each year and has risen by about 30 per cent since 2000.
Getting married for tax reasons may not sound very romantic, but along with making a will and drawing up a lasting power of attorney, it forms a crucial part of estate planning.