While individuals, asset managers and governments across the developed world have long focused on retirement planning – i.e. saving and investing for the golden years – surprisingly little attention has been paid to decumulation planning.
As life expectancy lengthens and expected retirement spans extend, the importance of planning how to deploy accrued savings to support retirement has never been more acute.
How to invest while in retirement
How should retirees in Hong Kong invest during retirement given lengthening life expectancies and the increasing risk of higher inflation?
In January 2018, Schroders undertook a study of Hong Kong residents’ views of investment, savings and spending as they look towards retirement. The Hong Kong Retirement Research is based on interviews with 700 people, from those who were eight years before their retirement to those retired.
In the video below, Lesley-Ann Morgan, our Global Head of Defined Contribution and Retirement, shares some of the valuable insights from this latest research and highlights three key lessons to help with those who are starting to think about retirement and also those who have recently retired.
On average, participants in our Hong Kong Retirement Research say they aim to save an average of HK$2 million for retirement, and they expect to spend on average HK$12,800 per month when they have stopped working.
With lengthening life expectancies, HK$2 million is likely to be inadequate. Hong Kong men are expected to live to an average of 81 years and women to 87 years1. For a person planning to retire at 65, HK$2 million will be drawn down in 16 years, assuming a 4-5% annual return on their savings.
Based on our research, those who make a clear financial plan for retirement and start saving about 14 years earlier would save around twice the amount compared with those with no plan. This means that if retirees have a plan for retirement, save and invest suitably, they're likely to be able to retire earlier than those who do not. Our findings also showed that those who had a plan, started thinking about retirement at age 43 while those who did not, considered it only at age 59.
The participants on average expect around an 11% return over a three-year period while allocating near 40% of their assets in cash and time deposits. About 65% said they wanted to leave about HK$2 million, the same amount with which they expected to retire, to their family when they pass away.
An 11% return on investment is unrealistic for a cash-heavy retirement plan. With investment strategies concentrated on low risk and low return assets, a retiree’s reserve may not be adequate to cover the three key risks that people face in retirement: living longer than expected, experiencing higher inflation than expected and getting lower investment returns than expected.
We believe if a portion of an individual’s retirement savings is put into a government-backed annuity scheme such as the recently proposed Hong Kong Mortgage Corporation (HKMC)’s plan, the remainder should be invested in suitable growth assets. The best strategy is not to completely de-risk at retirement. Investing via a diversified approach offers the ‘Goldilocks’ of investment trade-offs: neither too much risk nor too little return. This should help to generate the income and returns that Hong Kong retirees need and want.
For details, refer to Schroders: Post-retirement solutions – Putting your savings to work (August 2017).
The research showed that about 80% of the people rely on relatives and friends for recommendations, and only 54% would seek advice from bank relationship managers or financial advisors.
This poses the risk of being exposed to a mix of information that may not be professional advice and may leave Hong Kong people vulnerable to having their individual character traits influence their ability to make rational investment decisions.
Hong Kong’s Interest Towards Government Annuity
Later this year, the government-owned Hong Kong Mortgage Corporation (HKMC) will launch the city’s public annuity scheme, which would allow elderlies aged 65 and above to invest HK$1 million in exchange for a guaranteed monthly income until death.
Based on our research findings, 19% were either very interested or quite interested in annuities as an investment option.
When asked specifically regarding interest in the life annuity scheme, 30% were either very interested or quite interested. Furthermore, 52% of respondents were either very interested or quite interested in insurance savings plans, many of which have annuity-like mechanism built-in.
Separately 34% of the respondents were ‘neutral’ on the HKMC scheme, which could mean that they were waiting for more information about this programme.
Based on the findings, Hong Kong people generally have quite a high interest in annuities compared to many other regions around the world. The level of interest may be due to the fact that the scheme provides for a monthly income for life.
Based on our research findings, we believe that the optimal post-retirement solution for Hong Kong people would be a combination of cash for immediate spending needs, an annuity and some higher risk investments to provide growth and income for the future. The plan should involve accepting more calculated equity risk as it should substantially improve the chances of maintaining purchasing power against in inflation and growing savings.
Please visit the “Post-retirement solutions” tab for more insights on how Schroders could help structure solutions for retirees.
1 2017 global life expectancy ranking, Ministry of Health, Labour and Welfare, Japan.↩
Schroders’ undertook a study of how retirement saving are utilised in markets across the world. We found that no market – including Hong Kong – has yet solved the puzzle of the most appropriate post-retirement investment solution.
A common thread across these markets is the conflicting objectives savers face and the fact that most participants have not contributed enough to their defined contribution pension plans.
Lengthening life spans complicate retirement planning
With elderly populations growing and individuals living longer than ever in Hong Kong and across the developed world (see Figure 1), there is growing awareness that most individuals are not saving enough to meet their needs in what is likely to be a longer-than-expected retirement.
Figure 1. Life expectancy has steadily risen, with Asia leading the globe
Source: United Nations, Department of Economic and Social Affairs, Population Division (2017). World Population Prospects: The 2017 Revision, custom data acquired via website.
Asia leads global growth in post-retirement populations
As healthcare improves and life expectancy continues to rise, old-age dependency ratios1 are rising across the globe.
- Asia’s old-age dependency ratio of 11.1 was slightly better than the global average of 12.6 in 2015.
- This is expected to change by 2050, when the region’s ratio is forecast to reach 28.4, eclipsing the global average of 25.6.
- Hong Kong’s situation is particularly acute, with its old-age dependency ratio estimated to more than triple from 20.6 in 2015 to 64.6 in 2050 (see Figure 2).
- This will leave Asia home to an aggregate old-age population that exceeds that of the rest of the world combined (see Figure 3).
These point to a pressing need for governments, financial institutions and individuals to prioritise post-retirement planning.
Figure 2. Hong Kong tops Asia and global old-age dependency
*Old-age dependency ratio = ratio of population aged 65+ per 100 population 15-64
Source: United Nations, Department of Economic and Social Affairs, Population Division (2017). World Population Prospects: The 2017 Revision, custom data acquired via website.
Figure 3. Asia’s old-age population to exceed the rest of the world’s by 2050
Source: United Nations, Department of Economic and Social Affairs, Population Division (2015). World Population Prospects: The 2015 Revision, DVD Edition.
Retirement planning considerations and risks change over time
When thinking about post-retirement planning, we find four key “known unknowns” that individuals need to take into consideration:
- How long will I live?
- How much will things cost in the future?
- How much income will my investments generate?
- What goods and services will I consume?
And the answers to these questions are moving targets. As Figure 4 illustrate, the risks they represent are not static but actually shift over time. For example:
- Returns – The value of a defined contribution pension will likely be largest in the years immediately preceding and following retirement, making it most susceptible to market volatility at this time.
- Inflation – Inflation, which has ranged from about -2% to about 8% in Hong Kong over the past 10 years2, is of more concern in the early years of retirement – when a retiree faces decades of inflation and a shrinking asset base – than it is 20 years into retirement.
- Longevity – Longevity risk, the risk of outliving one’s sources of income, increases with age as it is more likely that an 89 year old will reach the age of 90 than it is for a 65 year old.
Figure 4. The significance of retirement risks change over time
Source: Schroders. For illustration only. February 2015.
With two centuries of experience, US$520.6 billion in assets under management and 4,100 investment professionals worldwide, Schroders is a truly global investment partner. This includes more than 45 years in Hong Kong, where we understand that employers are concerned about their employee’s post-retirement welfare.
There is growing recognition that simply relying on a cash lump sum in retirement will not meet retirement funding needs. We see an opportunity for employers and pension scheme sponsors to work with an investment partner, like ourselves, to implement well designed investment solutions that address their employees’ key risks in retirement and help to deliver income security in the face of uncertainties such as longevity risk, inflation and the unpredictability of returns.
1 Old-age dependency ratio = ratio of population aged 65+ per 100 population 15-64↩
2 Bloomberg, accesses 5 June 2017. Monthly year-on-year inflation for the 10-year period troughed at -1.6% for 31 August 2009 and peaked at 7.9% on 31 July 2011.↩
Schroders believes addressing the post-retirement challenge requires a two-pronged approach:
- On the one hand, governments, employers and asset managers must continue to support individuals during the asset accumulation phase of their lives to ensure they have sufficient savings at retirement.
- On the other, there is a need for increased focus on the too-often-ignored decumulation phase of life, when retirement savings are being drawn down.
Crafting a decumulation strategy that works
In our study of decumulation strategies worldwide, including in Hong Kong, we found that every individual faces a balancing act between addressing the features they need and those that they want.
In searching for this balance, Schroders works with employers and sponsors to consider the tools plan participants have at their disposal, which comprise three key options:
- A cash lump sum is the simplest option. It allows individuals to control their own funds, but also leaves them with all of the responsibility and risk associated with managing decumulation.
- Utilising individual accounts allows an individual to adjust income levels throughout the decumulation process. At the same time it offers the flexibility to choose underlying investments while also having the option to access the benefits of a lump sum and an annuity.
- Annuities provide a reliable income stream while an insurer manages the associated pooled risk. The income stream can be set at a flat level or rise over time and, similarly, can start immediately or in the future. Annuities can also deliver the peace of mind of including guaranteed spousal benefits.
Creating a tailored decumulation strategy
There is no single option that produces a suitable solution for everyone. Rather, any given post-retirement decumulation strategy is likely to utilise a combination of these options in order to meet the key needs of individual retirees in Hong Kong. Schroders believes there are four key areas where such a solution must deliver:
Default to a tailored decumulation plan
With so much uncertainty surrounding post-retirement planning and myriad options available, an ongoing debate in the asset management industry surrounds the potential for governments and employers to offer a “default decumulation strategy”.
While the simplicity of this approach is appealing, Schroders believes planning a decumulation strategy for any one individual is simply too complex for such a prescriptive approach to work as:
- Everyone’s circumstances differ meaning a default strategy may not match a given individual’s needs.
- Improved financial literacy and the availability of web-based resources empower individuals to make their own accumulation and decumulation choices.
- Many individuals highly value choice.
- It would be impossible to get all stakeholders across government, plan sponsors and asset managers to agree on one default plan.
In fact, our research and discussions with stakeholders suggests that an individually tailored post retirement plan is the only plan that should be considered “default”.
This does not mean leaving plan participants at sea amid a hundreds of potential decumulation plans. Rather, Schroders suggests providing retirement plan participants with a short-list of appropriate plans that have the potential to deliver longevity protection despite continued inflation and the potential for capital market volatility.
To explore the key considerations for decumulation planning further, please download our reports using the buttons below.
Experts from Schroders discussed these challenges and solutions in an article for Asia Asset Management. Lesley-Ann Morgan, Global Head of Defined Contribution and Retirement and Chris Durack, CEO of Hong Kong and Head of Institutional Asia Pacific shared their views and opinions on the topic.
A mix of annuities and outcome-orientated investments for retirement
The importance of continuing to hold growth assets during the decumulation phase
Retirement research1 carried out by Schroders with 700 people, who were in or near retirement, found that respondents target to save an average of HK$2 million (US$254,814) for retirement, and on average expect to spend HK$12,800 per month when they have stopped working.
But retirees in Hong Kong have among the highest life expectancy in the world, with men expected to live to an average of 81 and women until they are 872.With the average person stopping work when they are 63, men will need their pension account to last for 18 years on average, while women will need it to last for 24 years on average.
Lesley-Ann Morgan, global head of defined contribution and retirement at Schroders, says: “If people do have around $2 million at retirement and you look at how people invest, which is quite conservatively, their money will probably only last 16 years even with some low singledigit returns.”
The research found that on average, people allocate nearly 70% of their assets to cash, time deposits and insurance policies and other lower risk/return assets, with the next major allocation held in equities.
Ms. Morgan points out that with inflation and the high life expectancy in Hong Kong, people risked seeing their quality of life erode as they got older if they kept such a high allocation of their assets in cash.
An annuity anchor and growth investing
Ms. Morgan says one approach would be for people to consider putting some of their money into an annuity. Also from the Schroders research, 19% of the respondents were either very interested or quite interested in annuities as an investment option.
The Hong Kong Mortgage Corporation is launching a Life Annuity Scheme in July, which will enable savers aged over 65 to convert a lump sum into a regular income for life, guaranteed by the Government. The Schroders research shows that 30% of respondents are either very interested or quite interested in this public scheme.
“We are glad to see relatively high local interest towards annuity products, as we believe that should play a role in retirement financial planning. An annuity, be it from the public or private sector, will provide quite a stable base in terms of the income people will get, which would then give them more bandwidth to take on risk and to put the rest of their money in market-linked assets that have a bit more growth,” Ms. Morgan says.
But she thinks annuities only form part of the answer for generating a retirement income.
“The annuity from the Hong Kong Mortgage Corporation has fixed increases. It doesn’t have inflationary increases,” she says.
Instead, she thinks people should consider blending an annuity with other products that give more growth to provide a buffering against inflation.
Outcome-orientated strategies to combat sequencing risk
Ms.Morgan particularly likes outcome-oriented investment products that are designed to provide a return above inflation.
She adds that one of the issues with investing in a non-outcomeoriented way is that there is a risk of just following the market up and down, particularly if people invest passively or into plain vanilla equities.
“The amount of skill people need in those last ten years before retirement is quite important because there is a trade-off between preserving capital in the fund but also trying to grow the assets at the same time,” she says.
Ms. Morgan adds that an outcome-orientated solution is particularly important in the 15 to 20 years after retirement. “This is when sequencing risk first begins to be an issue, because if you have a large account size and you have a significant fall in the account early on, you can never regain that as you are actually drawing assets out of the account all the time,” she says.
Stronger post-retirement role for the MPF regime
Schroders sees generating an income flow in retirement as being an imminent challenge, and it is prepared to work with the authorities and pension scheme providers in Hong Kong to help shape the best solutions.
Chris Durack, chief executive officer, Hong Kong & head of institutional business, Asia Pacific, at Schroders, says: “The Hong Kong Mandatory Provident Fund system could be used to not only help Hong Kong workers save for retirement but also to offer them decumulation solutions. It could do this by providing a number of different default solutions in which people could invest, enabling monthly drawdown, but also factoring in the growing longevity risk and evolving returns environment.”
South Africa has recently introduced legislation allowing for default post-retirement investment if people do not make their own choice or leave the plan.
Authorities in the UK and Australia are also considering default options.
Ms. Morgan says: “In many countries around the world we are seeing a call for there to be more institutionalisation of post retirement.”
1 Schroders’ Hong Kong Retirement Research interviewed 700 Hong Kong people from those eight years before retirement to those retired in Jan 2018.↩
2 2017 global life expectancy ranking, Ministry of Health, Labour and Welfare, Japan.↩
Important Information: This document is intended to be for information purposes only and does not constitute any solicitation and offering of investment products. Investment involves risks. This material has not been reviewed by the SFC. Issued by Schroder Investment Management (Hong Kong) Limited.
Source: Asia Asset Management May 2018