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.
Expert from Schroders discussed these challenges and solutions in an article for Investment Innovation Institute. Chris Durack, CEO of Hong Kong and Head of Institutional Asia Pacific shared his views and opinions on the topic.
Hong Kong shows careful optimism on annuities
When former United Kingdom Chancellor George Osborne announced in 2014 that from April the following year, UK citizens would no longer be required to convert their pension savings to an annuity at retirement, the £12 billion-a-year annuity industry produced an almost audible gasp.
And rightfully so.
While in the second quarter of 2013 still 89,000 annuity contracts were sold, just over a year after annuities were no longer mandatory, quarterly sales had fallen by 81 per cent to a mere 17,000, according to figures from the UK regulator, the Financial Conduct Authority.
Although some recovery of sales has been predicted, the interest in annuity products remains muted.
Considering this response, it might come as somewhat of a surprise that the announcement by the Hong Kong Mortgage Corporation (HKMC) – a state-owned vehicle that promotes wider home ownership and banking stability – that it was launching a lifetime annuity product for retirees from this month onwards was greeted with noticeable enthusiasm.
In a survey, commissioned by Schroders, of 700 people in Hong Kong who were approaching retirement or in retirement, 30 per cent of respondents said they were ‘somewhat’ or ‘very interested’ in allocating funds to the HKMC annuity scheme, while almost 20 per cent of respondents indicated they were ‘very’ or ‘quite interested’ in annuity schemes.
“The annuity has some interesting features and characteristics,” Chris Durack, Chief Executive Officer, Hong Kong, and Head of Institutional Business, Asia-Pacific, at Schroders says in an interview with [i3] Insights.
“The fact that it is essentially government guaranteed tends to generate a bit more interest than you would otherwise expect.
“If you look at how people are investing their retirement savings at the moment, a very small proportion has been allocated to annuities. [On average, the allocation to annuities] was somewhere in the vicinity of two to three per cent of their overall portfolio. But then when you look at our survey outcomes, the interest in the HKMC annuities was at about 20 per cent of respondents.
“But how this actually translates into an allocation depends on quite a number of factors, including how it is distributed.”
In Hong Kong, most people save for their retirement through the Mandatory Provident Fund (MPF), a compulsory retirement saving scheme, and it is unlikely it will distribute the new annuities as part of its platform.
This means residents would have to make a separate allocation to the HKMC themselves, which might prove a deterrent for some.
There are also caps placed on how much residents can put in the new annuity, with the minimum set at HK$50,000 (A$8600) and the maximum at HK$1 million (A$170,000).
“It is unclear how much people will allocate between the maximum and minimum,” Durack says.
“At the moment, all you can say is that there is quite a lot of interest here.
“But let’s see how the rollout occurs and what supporting services are available to help people understand how the annuity can make a contribution to their overall retirement portfolio.”
Conservative Allocations, Optimistic Expectations
Currently, Hong Kong residents who are retired or close to retirement have very conservative asset allocations, allocating on average 38 per cent to cash or term deposits. But the survey found a startling disparity between these allocations and people’s expectations of investment returns.
On average, Hong Kong residents indicated they expected to achieve an 11.3 per cent return over the next three years.
“One very stark observation in the survey data was that when we asked people: ‘What are you doing with your accumulated balance in your MPF scheme at retirement?’, the majority of respondents had withdrawn their balance and went on to invest the lump sum in a very conservative way,” Durack says.
“The average investment was the majority in cash and the minority in equity investments. And yet, the expected returns, when you asked investors what they hoped for in their retirement portfolio, was still double digits. This obviously implies some level of disconnect in terms of what they were expecting from their investment portfolio and how conservatively it was invested.
“That led us on to thinking: ‘What would help here?’ For those investors that did get financial advice earlier on, they tended to have a much higher level of savings. On average, that cohort of investors was saving about double compared to those that were not advised.”
The survey found Hong Kong residents who received advice had not only more realistic expectations, but also better retirement strategies in place.
“If you are not accessing advice, then the expectations for the capital that you are saving might not be realistic, the sum that you are saving might not be adequate and the retirement planning is a long way behind where people feel they need to be,” Durack says.
But these findings were not unique to Hong Kong. In a similar study conducted globally, respondents also indicated much higher expectations of returns than what their asset allocation would justify.
“The result that people were expecting double-digit returns on their portfolios was consistent with a global study we did in 2017. There is an optimism bias in these results,” Durack says.
“Perhaps people focus more on the equity holdings they have in their portfolio. Are people looking at the entirety of the portfolio in informing their return expectations? That is a very good question.”
Balancing Growth and Conservative Assets
The introduction of an annuity product could push people further into conservative assets, while they might benefit more from an allocation to growth assets, but Durack says that if implemented in a sensible way in a broader portfolio, annuities have a role to play.
“Annuities can provide some stability and income contribution and it can also, in the case of a lifetime annuity, help manage the longevity risk as well,” he says.
“But inflation is a very big risk to manage in retirement, especially where people on average have 20 years plus to live in retirement.
“So you need to balance those risks and growth assets have a very critical role to play over those time frames as well.
“But the point here is that if there is more education and there are more tools available to help investors understand what a market-linked decummulation portfolio looks like alongside an annuity product, then this might help people think through how much they should invest in conservative allocations, including annuities, and how much they should expose themselves to growth assets.”
This article has been reprinted with the permission of the Investment Innovation Institute [i3]. For more information on the [i3] Insights newsletter, please visit: https://i3-invest.com/insights/
Find out more
Our business is structured around a number of strategic capabilities, which combine to meet a variety of client requirements. Please visit the Strategic Capabilities - Retirement page to discover how we help our clients improve their retirement journey.