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Building up a pension pot is hard. But running it down can be surprisingly tricky too. The combination of investment and longevity risk makes the decumulation of pensions the “nastiest, hardest problem in finance”, according to Nobel Prize-winning economist Bill Sharpe.
Worries about running out of money make retirees frugal. They hang on to four-fifths of their savings, even after two decades of retirement, wrote BlackRock’s chief executive Larry Fink in his annual letter to investors this year. He trumpeted a new product from the world’s largest asset manager called LifePath Paycheck that reduces uncertainty by automating investors’ asset allocations and simplifying annuity purchases. It promised a “revolution in finance”, he claimed.
There are hurdles, though. Investor demand for a handful of similar products launched since 2020 has been muted, according to data provider Morningstar. One issue is that the fees charged for annuities are opaque. The risk of litigation is likely to worry plan sponsors.
There are similar, but not identical, dilemmas elsewhere. In Britain, most pension providers will start to de-risk savers’ investment portfolios — by increasing the weighting of bonds, and sometimes property — six to 10 years before their intended retirement date, unless a saver opts out. US funds group Columbia Threadneedle Investments reckons the UK should follow Australia, where two-thirds of schemes do not use this “lifestyling” approach. It calculates this lower exposure to equities reduces returns by 2.3 per cent per year.
There is indeed a strong case against shifting out of equities, at least in the early years of retirement. The reputation of bonds as safe assets, never well-founded, was severely dented in 2022 when some pension pots of people on the brink of retirement were drastically cut. But simply copying Australia might be a mistake as UK schemes are less well-funded.
Compelling people to buy annuities, as the UK did before 2015, is not necessarily the right solution either. Compulsory annuity purchases makes the most sense in countries with little in the way of a state pension. In the UK, by contrast, the state pension is the equivalent of an annuity index-linked for life worth £300,000, says Sir Steve Webb, a partner with pensions consultancy LCP. As a minister in the coalition government, he opined that if a retiree chose to blow their pension on a Lamborghini, that was their choice.
But many retirees, even wealthy ones, do not feel confident enough to make any pensions decisions, including whether to splash the cash. Choice overload, loss aversion and regret avoidance are hard obstacles to overcome. Solving this conundrum for boomers, the wealthiest retiring generation in history, would yield a big prize.
vanessa.houlder@ft.com
