• how much income will the pot generate year by year?
Behavioural economics tells us that people generally underestimate how long they will live – perhaps based on the experience of older generations – and they will be over-optimistic about how much income their investments will produce, or how stable it will be going forwards.
I believe there are significant risks here whereby policyholders could make poor choices unless they get access to good advice. Actuaries need to highlight these risks and try to give helpful information to assist in the decision-making process.
Step 4) involves considering what other income sources are available and how much the pensioner needs (or wants) to receive in order to sustain a certain standard of living. Here, step 3 obviously interacts, as the policyholder will need to be clear on whether or not the income stream from their pension pot is fixed (as an annuity would be) or whether it has the prospect of fluctuating widely or even being exhausted if the policyholder lives too long. Again, actuaries need to be alive to this new information need and find creative ways to inform pensioners.
Step 5) considers the tax implications. This is, of course, far from straightforward and an area where good guidance and advice will be very important as it will be easy to get this wrong. For example, policyholders who have a desire to buy a Lamborghini with their retirement pot should be made aware that such a car (low mileage, one careful owner) could cost £200,000. So to afford one you are likely to need a pension pot in excess of £350,000 (at a marginal tax rate of 45 per cent) and they should be content with paying the taxman as much as £150,000 for the pleasure.
Perhaps a more common reaction will be to try to minimise the amount of tax to be paid – but that would mean restricting the level of income each year to relatively low levels (£10,000 for 2015/16 tax year). This is a difficult area indeed and one in which it would appear to be very easy for policyholders to misunderstand some of the nuances or for advice to be insufficiently detailed.
Step 6) yields more challenges. We are quietly confident that the actuaries at each and every insurance provider that has been actively operating in the annuity market will be developing a new flexible income product. However, few have as yet revealed what this will look like in detail. So for advisers and pensioners alike we expect that there will be a large number of similar though all slightly different products to try, compare and contrast and evaluate which of them might be most suitable given the individual circumstances of each pensioner. Actuaries will need to provide clear information in a simple format highlighting the key features of their products.
