moneyFYI
Financial Freedom Is Merely Organized Common Sense
Facts Do Not Always Add Value
In Britain, the recent budget scrapped rules that require pensioners to buy an annuity. Beginning in 2015, it will be easier and cheaper to withdraw money from pension plans.
To offset any problems, Pensions Minister Steve Webb proposes to tell people their “rough life expectancy.” The government expects that people will use this reasonable lifetime when deciding how much they can afford to spend each year.
Good luck with that.
Making it easier to withdraw pension money sooner will have impossible to correct, adverse consequences.
- People are generally not rational. The British government should listen to Keynes, “Nothing is worse than a rational policy in an irrational world.” The proposed flexibility will be valuable only to already capable financial managers. But the others, the people who do not have the “save first” mindset, are unlikely to acquire to skill. Old rules forced them to provide for their advanced years; new rules will not.
- “Saving pays off some other day; spending pays off today.” Compared to future concerns, the present is dominant. People use hyperbolic discounting to assess future value. Any financial benefit more than a few years away is near valueless. Large early withdrawals will be commonplace.
- Money needs a guardian, but many don’t use one. A belief perpetuated by government and media is that investing is rigged in favour of the advisers, so a majority of people in Britain, do not have an adviser. Financial planning is not an easy do-it-yourself task. Good advisors provide a conscience as well as advice.
- “Life expectancy” is not predictive for any individual. Given current age, gender, health, family history, lifestyle and geography, it is the median survival age of a large group of people.
- Life expectancy changes. The longer you live, the longer you can expect to live. In 1883, when Bismarck created age 65 as an important retirement age, life expectancy for new retirees was less than age 75. Today, easily half the 65-year-olds will be alive at 85. Of the ones who reach 85, half will live past 93 and, of those, half over 98.
- Annuities are more subtle than people think. One factor is “mortality gain.” Essentially, survivors win what people who died too soon lose. I have a client who buys annuities because his father died at 101 and his grandfather died at 99 in a car accident. He is betting that the insurance companies have mispriced his unique mortality because they use whole population averages. Could be true, too.
Flexibility is a desirable value and for some people the new rules will work in their favour, but retirement asset consumption plans deal with far more than life expectancy.
Neither investing nor retirement spending plans are foolproof. Knowing average life expectancy will not work to overcome the tendency to spend money sooner rather than later.
The result: Easier access to pension funds will harm those who least can afford it.
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Contact: don@moneyfyi.com | Follow Twitter @DonShaughnessy
Don Shaughnessy is a retired partner in an international public accounting firm and is presently with The Protectors Group, a large personal insurance, employee benefits and investment agency in Peterborough Ontario.
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