Happy Christmas Day!
2022 has brought us one guy who has filled us with good cheer. Stefan Lundberg is that man and over the Christmas period I want to republish a few of his great articles and blogs of 2022 which I have missed through the year. To kick things off, here is a wonderful blog on pension communication, which was published in blazing August but is well read this Christmas Day!
Retirement Years sounds like it could be a ‘feel-good’ movie at one of the streaming services. It is not a strange thought, since our intrinsic happiness is highest early and late in our lives. An economist would describe happiness as a U-shaped utility curve with the midlife crisis as the low point. Money cannot buy us happiness. But we should make sure that we have some retirement savings so that we have the financial means to do what we enjoy in what should be the happiest time of our life. Don Ezra, the pension expert and author, has written a lot about this so I recommend that you visit his blog.
The main challenge for us, the pension industry, is to help members visualise what their pension savings will bring them. Following the Albert Einstein’s words of wisdom “make it as simple as possible, but not simpler”. I think that the answer is to condense everything to one simple, personalised measure which doesn’t require a manual. The concept of Retirement Years is therefore something that has been brewing in the back of my mind for a long time.
Addressing the information need
Pensions is not rocket science; you put away money while working and use the savings to complement your state pension later in life. Most people understand that life does not always turn out as planned, but they want an indication of what they are on track for, if they continue to work and pay contributions until their retirement. A simple approach would be to provide the member with a projection of how many years of ‘good’ retirement income their current path may give them. This is basically the definition of Retirement Years and it is communicated in years and months.
Retirement Years are also helpful when explaining the consequences of different decisions that the member may take. For example:
‘By increasing your monthly contributions by 2 per cent, you add 3 years and 2 months to your Retirement Years’
‘By taking the tax free lump sum at age 55, you reduce your Retirement Years by 4 years and 8 months’
You could also use the concept of Retirement Years to help illustrate the consequences of taking paternity/maternity leave, or moving to part-time employment.
At retirement, the savings pot is what it is and the member has to make prioritisations. For someone reaching their retirement with a pot that corresponds to 13 years and 7 months of a certain retirement income, they need to think about how to spend their savings. Once the pension pot has been spent, the member has to live on the state pension alone. Explaining the effect in Retirement Years can help members to make decisions. For example:
‘If I take a lower income, how many more Retirement Years will that buy me?’
‘I want to target a specific level of income for the first 7 years, what level of income can I expect if I want my remaining Retirement Years to last until I am 85?’
From theory to practice
To move from theory to practice, the first piece of the puzzle is to determine what a good retirement income looks like.
The Pensions and Lifetime Savings Association (PLSA) in the UK, has prepared a framework, the retirement living standards, based on different consumption baskets for retirement. This is an important step since it anchors the income needs to consumption in retirement, rather than to your current salary level. Combined with projections of your future contributions and investment returns, this forms the base for the Retirement Years.
Life is full of surprises, we simply don’t know what is going to happen in our personal life, the real economy and the financial markets. Given the massive uncertainty, and the member specific circumstances, the best we can do is a basic “what if” analysis based on what we know about the member to help them with some high level planning. On top of that financial markets are another source of uncertainty and we all know that historical investment returns are no guarantee for future returns.
A personalised projection is not a prediction
The Retirement Years is simply a personalised projection that helps the member to determine if they are on track. Your projection is based on; your preferred consumption basket, that you will continue to work and pay contributions until you retire, that financial markets perform according to the assumptions, and that the investment portfolio is de-risked according to its lifecycle strategy.
Some might argue that there is a risk that members will think of the projected Retirement Years as a promise. That risk could be mitigated depending on how it is communicated. Most people understand that changing to a part-time job will affect their pension. To most, it will not come as a surprise that if investment returns are lower than expected, it will affect your pensions. This is not rocket science, but we must be transparent.
Making planning easier
I find that most pension planners are painful to use. I have to fill in a lot of information which I don’t have easy to hand and I often give up before even completing the forms. To remove the hurdles, I think it would be easier if I was presented with the Retirement Years based on what my provider knows about my personal situation. Having a starting point, makes me more inclined to interact perhaps when triggered by a change in my personal life situation.
I believe that removing the industry jargon and unnecessary complexity should get more members to engage with their pensions. Retirement Years gives a personal and relatable way to explain the outcome of your pension savings. This will help members who currently don’t want to engage, by providing something they can understand when they do want to engage.
KISS – Keep It Simple Stefan
Thinking back to Einstein’s “Make everything as simple as possible, but not simpler”, opens up the question whether the Retirement Years measure is too simple? Personally, I don’t think so. Planning for retirement means making decisions under uncertainty. Using detailed stochastic modelling based on crude, and often incorrect, assumptions will only provide members with a false sense of security. “It is better to be roughly right than precisely wrong” as Keneys nicely put it.
This is where I have landed with Retirement Years. If you have other (and hopefully better) ideas, I’m all ears!