This is the last of a series of eight chapters which we hope will stimulate thought around the difficult issues that people may face while investing in retirement. Spire Platform Solutions does not provide advice and does not advocate any particular investment solutions.
Around two-thirds of pensioners live as couples, albeit not always with the partner they started off with, and not necessarily bound together in a legal marriage or civil partnership. What this statistic simply tells us is that in most cases, the sustainable investment plans we have talked about in the first seven chapters need to cover two people, not one.
We have left this chapter until last because when learning new concepts it is often better to start in a relatively simple environment and introduce the complexities of real life later. Rather like it’s better for a child to learn to ride a bicycle in the local park, and only progress to the public roads after they have acquired a competence in balance, steering and braking.
The couple may well have made their way through working life together as a team, and probably arrived at retirement with quite un-balanced individual pension wealth. The “gender pension gap” has been well documented by others such as NOW: Pensions, and what has typically happened is that one partner has taken a hit for the team, foregoing years of employment, returning to the labour market part-time and taking more local but lower paid jobs in order to provide the many hours of childcare that raising a family involves.
So, we’ll refer to the couple as Partner A and Partner B, and assume that Partner A has substantially larger pension assets in their name than Partner B does.
Before George Osborne’s Pension Freedoms, people were pretty much required to buy an annuity with their whole pension pot and choices were pretty simple. Responsible people bought a joint life annuity that continued to generate an income if they died ahead of their partner. Responsible life insurance companies employed staff whose job it was to ring up married customers trying to buy a single life annuity and tactfully enquire “were you aware, that you could buy a joint life annuity that will provide for your spouse/partner after your death?” Inserting this information even at the last minute usually had the desired effect of deflecting customers from irresponsible behaviour.
Today we have been un-yoked from the requirement to buy an annuity, and sustainable income investing is all about how to make your pension pot go further by spreading your investments. And we need to maximise every ounce of efficiency, as pension pots get smaller with each generation while at the same we are living longer so the pension must last for even more years than for our parents. In the previous chapters we have seen how important it is to have a diversified spread of investments and how replacing some or all of the bond portfolio with an annuity can lead to improved outcomes. Traditionally we would have said that the responsible thing for Partner A to do would have been to buy this as a joint life annuity.
But we set out on this journey to challenge traditional thinking and to see if there are alternative approaches that might be better. Of course Partner A wants to provide for Partner B in the contingency that A dies first. But which of their pension assets do they want to earmark for this, and which of their assets do they want to consume together with their partner while they are both alive? This may sound heretical, especially if you previously worked on one of those insurance company phone desks that rang up egregious men trying not to provide for their wife, but there are advantages in earmarking assets other than the annuity for the important task of providing for Partner B’s later life.
Buy the insurance you need, not the insurance you don’t is a good guiding principle. And one that is likely to lead to better outcomes as insurance is expensive, especially so for long tail risks. Cast your mind back to the earlier chapters, where Partner A was buying an annuity as part of a diversified retirement income portfolio, investing say between 10% and 20% of their funds in the annuity.
Let’s stop and think what happens if Partner A does buy a joint life annuity with this money. If Partner B dies first, then the whole exercise has been somewhat useless, as the annuity will have produced a lower income while Partner A was never worried about the financial consequences of outliving Partner B anyway. If it’s the other way round, and Partner A dies early, then again the exercise will have been un-necessary as there will still be plenty of the investment assets left to provide for Partner B. Insurance is not free, and insuring Partner B’s longevity at the same time as Partner A could be inefficient and indeed the question that arises is how much insurance will be needed at a potentially distant time in the future. An alternative is to buy a single life annuity as just a part of Partner A’s portfolio, and to ring-fence some of the investment assets as potential future provision for Partner B, keeping the value of ring-fenced assets under review to ensure it continues to be the appropriate amount taking into account age and health of Partner B.
Then, if Partner A dies first these assets can be used to purchase a single life annuity for Partner B. As by then Partner B will be older, the rates will be sharper, and if Partner B has developed adverse health conditions a medically underwritten annuity can provide even more income. On the other side of the coin, if Partner B dies first, then those same investment assets are still available and can be re-orientated as planned inheritance for the next generation, or even, thanks to the Pension Freedoms, passed over to them now, net of tax payable.
This is a complex decision; it needs to be taken with the help of a financial adviser, as part of an ongoing plan through retirement and looking at all the assets of Partners A and B, both pension and non-pension. But the traditional wisdom of “it’s a married couple, I must arrange a joint life annuity” is there to be questioned.
By Adrian Boulding - Chief Innovation Officer at Spire Platform Solutions.