Will Your Pension Run Out Before You Die?

What should income investors aim for in retirement? Income, obviously.

But research published last week by broker Hargreaves Lansdown highlighted the extent to which retirees are taking advantage of the new pension freedoms by also shooting for growth, as well.
Simply put, significant numbers of pension investors who have started drawdown with the firm since 6 April — the date that the new freedoms came into force — have opted to put a decent-sized chunk of their pension savings into growth-oriented stocks, funds and investment trusts.

1% yield

Taking a few at random, among the five most popular investment trusts were Scottish Mortgage Investment Trust and Woodford Patient Capital Trust, while the single most widely held share with drawdown investors was Lloyds Banking Group, closely followed by GlaxoSmithKline and Vodafone — these latter two former income stars now fallen on harder times.
And each case, it’s difficult to paint an income-centric picture — heck, the income currently paid by Lloyds, Scottish Mortgage Investment Trust and Woodford Patient Capital Trust is frankly derisory.
Why are supposed income investors doing this? Are they being irrational — or is there some underlying logic at work?

A monthly income — but how much?

First, let’s remind ourselves exactly what drawdown is: an alternative to traditional annuity schemes.
Instead of handing over all your pension savings to an insurance firm in exchange for a promise of a guaranteed monthly income, drawdown lets pension savers keep their capital, and draw it down as they wish. And, since the new pension freedoms have come in, that really is as they wish — the hated limits imposed by the government’s actuaries have been swept away.

So you get to keep your pension savings, for your heirs to potentially inherit — but, of course, there’s always the danger that your pension savings could expire before you do, if you draw them down too quickly.
And this, of course, was precisely the danger that the government’s actuaries’ drawdown limits were trying to address.

Going for growth

Suddenly, in that context, to have portion of your pension savings still in active ‘growth mode’ doesn’t seem such a bad idea.
Particularly if the investments in question are former income stalwarts (think Lloyds, GlaxoSmithKline and Vodafone, for instance) where although the short-term dividend prospects are muted, the longer term could be significantly better.
Or companies such as HSBC, BP and Royal Dutch Shell, where market forces are at work driving down share prices for well-understood reasons, holding out the prospect of buying into a decent yield at a bargain price.
Because if retirees’ assumptions about drawdown rates and their own longevity turn out to be too optimistic, and they do run down their core income-paying investments to danger levels, then those growth stocks and investment trusts will be there as a ‘backup’ to pick up the slack — either in the form of additional dividends, or capital gains, or both.

Will I die before my pension?

And the risk of retirees outliving their pension savings is very real — a risk that the removal of government actuaries’ limits has only increased, of course.
Because for more and more of us, ‘old age’ stretches out a lot further than it used to. Quite simply, as a nation, we’re living longer. Most of us are aware of that, of course, with increased average longevity regularly cited as one of the reasons behind tumbling annuity rates and increased retirement ages.
And according to Office for National Statistics population projections and life expectancy estimates, nearly one in five of us will live to see our 100th birthday.
Put another way, over ten million people in the UK today can expect to live to 100. Three million of these people are currently aged under 16, 5.5 million are aged between 16 and 50, and 1.3 million are aged between 51 and 65. Remarkably, around 875,000 are already aged over 65.

Taking a long-term view

In short, in a scenario when retirement might last for thirty or forty years, an assumption that all of today’s dividend superstars might go on delivering the goods could prove fatally naïve.
So building an element of growth into your pension pot seems like a smart move. In the short term, that will mean either saving a bit more, or settling for a somewhat lower retirement income.

But in the long term, the result will be a more prosperous retirement. Which has to be good news. 

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Malcolm owns shares in Scottish Mortgage Investment Trust, Woodford Patient Capital Trust, Lloyds Banking Group, GlaxoSmithKline, HSBC, BP, and Royal Dutch Shell.  The Motley Fool has recommended shares in Glaxosmithkline and HSBC.