Essential Personal Finance Chapter 10 Saving for later life © 2017 Lien Luu, Jonquil Lowe, Jason Butler and Tony Byrne

Contents Introduction Life expectancy Support ratio Retirement provision Incentives and nudges Charges How much to save? Annuities vs drawdown © 2017 Lien Luu, Jonquil Lowe, Jason Butler and Tony Byrne

Introduction L A T E R © 2017 Lien Luu, Jonquil Lowe, Jason Butler and Tony Byrne

Life expectancy Figure 10.1 Increase in life expectancy at birth between 1970 and 2013 Source: Data from OECD (2015a). © 2017 Lien Luu, Jonquil Lowe, Jason Butler and Tony Byrne

Support ratio Support ratio This is often defined as the number of people of working age divided by the number of people over retirement age, sometimes called the ‘old-age support ratio’ Trend in support ratios? Reasons for this trend? Criticisms of support ratio? Ways to improve the support ratio? © 2017 Lien Luu, Jonquil Lowe, Jason Butler and Tony Byrne

Retirement provision Figure 10.3 Five pillars of support for retirement Source: Author’s representation based on World Bank (2008). © 2017 Lien Luu, Jonquil Lowe, Jason Butler and Tony Byrne

Pay-as-you-go vs funded © 2017 Lien Luu, Jonquil Lowe, Jason Butler and Tony Byrne

Defined benefit vs defined contribution Types of scheme ? Planning ahead Risks borne by provider Risks borne by individual © 2017 Lien Luu, Jonquil Lowe, Jason Butler and Tony Byrne

Defined benefit vs defined contribution Types of scheme Some employer schemes Most state schemes Many employer schemes All personal plans Planning ahead Promised pension Uncertain pension Risks borne by provider Investment risk Inflation risk Longevity risk None Risks borne by individual Promise might be broken © 2017 Lien Luu, Jonquil Lowe, Jason Butler and Tony Byrne

Different models Scandinavian Main features? Differences? Anglo-Saxon Examples? Anglo-Saxon Continental Source: Blank map of Europe by Fobos92 - Own work, CC BY-SA 3.0, https://commons.wikimedia.org/w/index.php?curid=29805120. © 2017 Lien Luu, Jonquil Lowe, Jason Butler and Tony Byrne

Incentives and nudges Behavioural traits: Myopia Hyperbolic discounting Status quo bias Herd behaviour © 2017 Lien Luu, Jonquil Lowe, Jason Butler and Tony Byrne

Incentives and nudges Behavioural traits: Solutions? Myopia Hyperbolic discounting Status quo bias Herd behaviour Solutions? Tax incentives Automatic enrolment Compulsion (e.g. state schemes, private schemes in some countries) © 2017 Lien Luu, Jonquil Lowe, Jason Butler and Tony Byrne

Charges: an example If a person saves £100 a month in today’s money for 30 years and charges are 0.75%, how much of the pension pot is lost in charges? © 2017 Lien Luu, Jonquil Lowe, Jason Butler and Tony Byrne

Charges If a person saves £100 a month in today’s money for 30 years and charges are 0.75%, £7,600 lost in charges (11% of the pot) © 2017 Lien Luu, Jonquil Lowe, Jason Butler and Tony Byrne

Charges: another example If a person saves £100 a month in today’s money for 40 years and charges are 1.5%, how much of the pension pot is lost in charges? © 2017 Lien Luu, Jonquil Lowe, Jason Butler and Tony Byrne

Charges If a person saves £100 a month in today’s money for 40 years and charges are 1.5%, £30,600 is lost in charges (27% of the pot) © 2017 Lien Luu, Jonquil Lowe, Jason Butler and Tony Byrne

Charges: key points Annual charges levied even if pot does not grow Small annual charge can take high proportion of total pot Effect is larger the longer the saving term and the higher the percentage charge (because of compounding) © 2017 Lien Luu, Jonquil Lowe, Jason Butler and Tony Byrne

How much to save? © 2017 Lien Luu, Jonquil Lowe, Jason Butler and Tony Byrne

Annuities vs drawdown Which age will apply to you? Figure 10.2 UK men and women aged 65 in 2015 expected still to be alive at different ages Source: Author’s calculations using data from ONS (2015). Which age will apply to you? © 2017 Lien Luu, Jonquil Lowe, Jason Butler and Tony Byrne

Drawdown options Figure 10.4 Drawdown options © 2017 Lien Luu, Jonquil Lowe, Jason Butler and Tony Byrne

Annuities vs drawdown Annuities Pros and cons? Drawdown © 2017 Lien Luu, Jonquil Lowe, Jason Butler and Tony Byrne

Annuities vs drawdown Annuities - Remove investment risk and longevity risk - Can remove or reduce inflation risk - But income may be lower - Secure income but inflexible Drawdown - Investment risk and ongoing charges - Might beat inflation - Longevity risk - Flexible, but income may have to be cut or run out © 2017 Lien Luu, Jonquil Lowe, Jason Butler and Tony Byrne

Conclusions Retirement planning – behavioural biases mean tend to put off until later Life expectancy – rising Support ratios – falling Retirement provision Five pillars, including state and private schemes Pay-as-you-go vs funded Defined contribution vs defined benefit Models: Anglo-Saxon, Continental, Scandinavian Incentives and nudges Tax incentives, automatic enrolment, compulsion Charges – small annual has big impact on pot (compounding) How much to save – start early, retire later Annuities vs drawdown Longevity risk, investment risk, inflation risk Flexibility Higher risks give chance of higher returns © 2017 Lien Luu, Jonquil Lowe, Jason Butler and Tony Byrne