LIFE expectancy has been increasing in the UK and other developed countries for years. Indeed, since the 1980s, life expectancy at age 65 has increased for males from 13 years to 18.4 years – a dramatic improvement.
Female life expectancy has also increased, though the gap between male and female life expectancy is closing.
The impacts on the pension landscape of these increases cut across many areas.
Loading article content
Governments of all political persuasions have been tinkering with state pensions for years, acknowledging that the system originally put in place many generations ago is simply unaffordable now.
The demographic shift over the past few decades now sees far fewer workers supporting – and paying for – the pensions of far more retirees. Something had to give.
The state pension age (SPA) has increased from 65 for men and 60 for women in stages to 65 for both in 2018, 66 from 2020, then 67 for those retiring between 2026 and 2028. Further increases thereafter will take place linked to life expectancy and a report on this is due out from the Government in May. Increasing the SPA mitigates the impact of people living longer. However, as well as increasing the complexity of the system (how many of today’s workers actually know when they will receive their state pension?) these increases in SPA bring into focus other aspects of life expectancy such as the wide variations that exist in different parts of the UK generally and certainly within Scotland.
In parts of Glasgow City, life expectancy is as low as 65 – so many of its inhabitants will not live to receive their state pension at all, or will only receive it for a short period. Yet, many of these people will have paid their taxes and National Insurance Contributions for most of their working lives just the same as those living in areas with far greater life expectancy.
Similar problems exist in the private sector pension landscape – most defined benefit (DB) schemes have large deficits, caused in part by increases in life expectancy. Many of those approaching retirement will be fortunate enough to have been members of these DB schemes, which are seen as the gold standard.
But while these are very generous schemes, there are concerns whether every member will receive their promised pension in full. Also, the shape of the income they provide in retirement may not actually match what the pensioner needs.
Generally, these schemes provide a pension which increases in payment each year, and so pay the maximum amount immediately before the pensioner dies, at which point a reduced pension kicks in to any surviving dependant.
Not all pensioners would like this shape of income and may prefer a higher pension with lower annual increases. This gives them greater income in the early years of their retirement when they may be more active and wishing to do more and less later on when they are less active and their spending needs reduce.
To overcome this prescriptiveness, more and more schemes are running exercises known as pension increase exchange to manage their liabilities and provide a choice for members, supported by financial guidance or advice to help them make informed choices. Changing the shape of a pension in this way is not appropriate for all members, some of whom may wish to have their highest income in later life to cope with likely care costs, which is why taking advice is key.
Members of defined contribution schemes also face challenges as their life expectancy increases. Traditionally, members approaching retirement would move an increasing proportion of their fund into cash and Government gilts – safe investments – either to buy an annuity or, following the greater flexibility introduced in 2014, to have a lower-risk investment strategy and greater certainty of income in retirement.
Given that life expectancy for many retirees will now be 25 to 30 years and even more in some cases, they could be losing out on the higher returns which may be achieved from investing in a strategy that will deliver over this longer time horizon.
The industry is however trying to do its bit too and many providers are amending their so-called “lifestyling” approaches, under which growth assets are progressively switched into safer assets in the run-up to retirement, to reflect this new paradigm.
Malcolm Paul is chairman of JLT Employee Benefits Scotland.