Death & Taxes: I never thought I'd live to be a hundred
All articles in this section are provided courtesy of Master Investor Magazine and are not necessarily the views of Alan Steel Asset Management.
I appreciate that for most of us financial planning is like watching paint dry. And after all there's plenty of time to start thinking about all that stuff. But is there? Have you ever sat down and given any thought to what happens if you live too long or die too soon? There's a fair chance you'll qualify for one of them. When was the last time you gave any real thought to how your finances would stack up if you were to snuff it tomorrow or lived much longer than you'd assumed?
Dying too soon is dead simple to protect against, if you forgive the pun. Get cheapo life cover. It's called Term Assurance. Buy lots of it and stick it in a simple Trust to make sure your loved ones aren't left high and dry while lawyers and HMRC fight it out divvying up your life savings. While you're at it go check what happens to your pension pot after an inconvenient death. And for goodness sake go get a will organised. It's astonishing how many just don't get round to it.
I've heard some crazy excuses for not bothering with a will, even from wealthy and otherwise switched-on professionals and entrepreneurs. Here's a couple of crackers. "Everybody
knows that when you die all the money goes to your wife." Not. And how about this one? "The reason I haven't a will yet is that I'm superstitious. I'm worried once I draw up a will, I'll die." No kidding. Both were multi-millionaires. One has died. Wonder what his wife made of the shambles she was left with?
The most common reason given for not getting round to having a will or updating an existing one is "I've plenty of time." Ever experienced what it's like picking up the pieces when somebody didn't bother with a will because they'd plenty of time? Trust me, it's a nightmare. It's worth remembering that even the Titanic had lifeboats. Not enough, as it turned out. Don't let that happen to your family.
Now for the harder bit: living too long. Let me share a story with you. There's this wise man, a Professor of Economics, and he goes on holiday in Ireland with his family, driving in the country in search the country pile he'd booked for the week. His road map is rendered useless a few miles from Dublin thanks to the country folks' fun activity of removing signposts, especially at crossroads. Outcome? They're lost.
Soon they come to an old chap sitting by the side of the road. Does he know the directions to their rented pile? Turns out he's doubly certain, to be sure to be sure. He points north and says to keep on this main road, then a mile and a half before coming to a hump back bridge you take a left. The wise economist thanks the old chap and drives off a few miles before realising they'd have to drive all the way to the bridge, then turn round, drive back a mile and a half and take a right. Life, however, doesn't offer you that second chance.
When you get to your choice of retirement, part or full, if you've under-provided and miscalculated, there's no turning back the clock. Congratulations. You're guaranteed to live too long with too little.
I've lost count of the reports released recently that make grim reading for the financial prospects of the majority in retirement. Yet no matter how much has been written over the last forty years about the risk of just scraping by after the salary stops, too many of us apparently think there's still plenty of time to think about it. Or that maybe something will just turn up. If you're banking on a lottery win be aware you've more chance, I'm told by a statistician with too much time on his hands, of being knocked down on the M6 by a donkey.
I've got more sobering news for you. Your future standard of living is in your hands now. Oh and by the way let me let you into a secret. Time accelerates as you get older despite what Einstein said. Ancient readers (like me) will remember British comedienne Thora Hird who famously said "When I was 40 I went into the kitchen to make myself a cup of tea and when I came out , to my horror, I found I was 65."
Broccoli and chocolate
Part of a presentation I used to give about the need for disciplined long term successful investment featured a slide called "A Straight Line to Retirement or an Uphill Struggle?" This simple diagram went well with another slide featuring a plate of Broccoli and a pile of Chocolate.
Let's face it: we all know that over our lifespan broccoli is much better for us, but right now a chocolate fix is much more fun. That's why we don't take pension/long-term planning seriously.
There's plenty of time for that. And we prove it by imagining a straight line between now and retirement. Twenty years? Well let's enjoy chocolate for another five then we'll take the broccoli seriously. It's only a quarter of the time after all. And we need new cars and more holidays. I could use a new iPhone, too.
Problem is it's not a straight line. It's an uphill struggle. Take any decent return earned in tax-free growth pension pots, and if you pay contributions to them for say twenty years the eventual fund value will be X. Miss the first five years and contribute for the remaining fifteen years gives you a fund of only half X. Einstein was right about this one. Compound interest is the secret ingredient in building long term wealth. Rule of 72! The earlier you start the bigger your pension fund and the better your lifestyle when the salary stops.
When in 1899 Otto von Bismarck (by the way he was 74 then) introduced the idea of a minimum state retirement pension he intended it to be aimed at the poor and only payable from age 70. Having presumably received advice from actuaries it's little wonder so little was paid out given average life expectancy at birth at the time was only 45 years. And if you did survive to 70 in poverty (a tall order) your average life expectancy by then was a mere two years. (As a matter of interest the US equivalent "state pension" was set up in 1935 providing benefits from age 65 when average life expectancy at birth was only 62.)
The problem is that these days people are living much longer on average. Take the differences between remaining life expectancy for retirees in 1970 and now. A male aged 70 in 1970 could expect to only have another nine and a half years of state pension benefit, whereas now he can expect an extra fifteen years, on average. Across the board for both men and women there's been increases in the last 50 years of over 50% in remaining life expectancy at age 70.
And before the current longevity innovations studied by Jim Mellon in his new book Juvenescence kick in to extend life spans, already the number of over 90-year-olds in the UK has risen from 67,000 in 1970 and 228,000 in 1991 to over half a million five years ago. And given the number of baby boomers around, the number of over 90-yearolds is projected to break through one million by 2027 and not far short of two million ten years later. Ouch! What's that going to do to state pension costs and private pension scheme deficits? It doesn't bear thinking about.
So unless you fancy lightening the financial load by being born in Blackpool (lowest life expectancy for boys) or Middlesborough (same for girls), if you want to have a decent standard of life in later years you really have to be prepared to get your own act together. I can't see the state continuing to be able to afford much more, can you? And if you're not prepared to take proper pension planning seriously I'd advise you to be nice to your kids because they'll choose your nursing home one day.
In the old days pension planning was straightforward for many. Being members of final salary schemes meant all the investment or inflation risks were taken over by employers. You retired and were promised a guaranteed pension for life which also protected you partner's income after your death. And you probably received increases over the years.
Or you had private pensions with decent guaranteed income levels or the chance to buy income on the open market… they were called annuities. This used to be quite acceptable up to the mid-1990s but as UK interest rates fell to levels not seen since the 17th century, and as UK Gilt yields followed them, annuity rates fell sharply. To get an idea of just how low they are now consider the best rate available to a would-be client of 56 keen to take his transfer value from his final salary scheme. He wondered what the rate would be for a 3% increasing income with a decent level of widow's pension should he die before her.
It was only 2.7% BEFORE TAX. Yes folks… For every £100,000 purchase, that's a gross income in year one of £2,700. At 3% increase each year it will take 24 years for the income to double (not including inflation, of course). No wonder thousands are opting for "drawdown" instead. But how are they going to manage risk? How do they select a sensible income level? What about investment returns? Or charges? How will they cope emotionally with a stockmarket crash? If you're 65 today and going to live to 90 I'd imagine there will be a few over the next 25 years.
What about health issues? What about your exposure to scams? The experience since Osborne's so called Pensions Freedom shows the over-65s are vulnerable to financial conmen. Divorce? For years there's been over 100,000 divorces in the UK every year for the over-60s. Ouch. Already there are almost two million "older" divorcees, up five-fold since 1991. Imagine what any of these could do to your income levels.
Cloud Cuckoo Land
A Financial Advice Market Review of the over-55s with pension pots found that the majority of them neither wanted independent advice nor were willing to pay for it. 60% said they didn't need any, 28% said it was a waste of time. In a September survey, 77% of those questioned said they preferred investing without any advice. Only 13% of men said they were willing to pay for it, but the average amount they were prepared to pay was probably less than their annual car insurance. Aarrghh! And there are still too many older savers hoping the high interest rate glory days of the 1970s and 1980s will return. In a survey a year ago 80% with pension pots said they didn't want to buy an annuity, but roughly the same percentage when asked what income they'd want said they desired one that was guaranteed to last until they and their spouse had died. That's an annuity. Doh!
To thrive financially in retirement it's quite simple. Start investing, using pension opportunities first, as young as you can. Invest on a long-term basis for growth. Take experienced independent advice after asking around for recommendations. Aim for at least £1 million in today's value in the kitty, hoping to top that up with any extra the state can continue to chip in. Make this a priority. It's broccoli not chocolate otherwise. Cloud Cuckoo Land beckons. And let me I assure you, that's for the birds.
Article courtesy of Master Investor Magazine