Have a nice flight: Retirement runways and the danger of landing too soon

The upcoming generation of retirees are going to be much more reliant on defined contribution (DC) savings than any previous group, so it’s even more important their investments are appropriate. And when we see explanations of how to reduce investment risk in the run-up to retirement, the outlined process often reminds us of a plane landing.

The savers start with plenty of investment risk, and then the DC provider acts as a pilot, aiming to guide them safely and smoothly to land at their stated retirement ages; diagrams of pension glidepaths (like the illustrative one below) show a smooth transition towards a known age and projected saver outcomes are shown at that retirement date. It’s all very intuitively appealing.

Flying wide of the mark

But there’s a serious problem. Our data shows that in reality, people retire over a wide age range, from 55 to up past 75, and their stated target retirement age is a very poor guide for what they really do. While many retire earlier than expected, some retire much later too.

So, in our plane analogy it’s like trying to land without knowing the distance to the runway and that has huge implications for how we should think about the approach to retirement. Lots of people won’t be fully de-risked as they retire earlier than expected and equally, some of them will have been in the at-retirement strategy for a long time, as they retire later than expected[1]. That can have some nasty impacts on outcomes.

A bumpy landing?

To show that, we need to set some example de-risking glidepaths. So, let’s assume people are holding a diversified mix of assets at age 50 with about two-thirds of the risk of equities. And then let’s assume their risk reduces over 10 years from age 55 so they reach the target at-retirement strategy at 65.

This leads to a stylised glidepath diagram like that below:

As for what the at-retirement investment strategy is, let’s consider two alternatives: firstly one that de-risks into cash, and secondly one that just marginally cuts risk to 50% of equities at retirement.

When thinking about the outcomes a retiree might receive, we need to consider circumstances where their investments perform well as well as cases where market returns are more disappointing. So, let’s focus on what an average outcome might look like as well as potential upside and downside scenarios.

We’d like to draw out three elements:

Firstly, if someone retires at 55 then the de-risking process hasn’t started and so the range of potential outcomes are the same no matter which de-risking solution they would have used.

Secondly, if someone retires at their stated retirement age of 65, then even in when the investment returns are disappointing, the route that de-risks less actually delivers a better outcome. We think this is intuitively surprising and it’s caused by a combination of disappointing returns before de-risking, and then lower-than-expected cash returns in the years just before retirement.

Thirdly, what’s most worrying for us is the impact for those that retire much later than expected, after being de-risked towards the ‘low-risk’ cash outcome; with retirement outcomes of 18-25% at less in the disappointing and average outcomes. The reason this can lead to such a poor range of outcomes is that savers are stuck in assets with low return potential for a prolonged period, potentially returning less than inflation. There will be scenarios where derisking into cash leads better outcomes than retaining 50% of equity risk, in particularly if people retire close to their stated target age. These will occur in more extreme, adverse markets where returns are particularly disappointing. We estimate the likelihood of these occurring is lower than the 1-in-10 scenario shown in the table.

Prepare for touchdown

Focusing now on those that retire later than expected, we can go back to the plane analogy one last time. The conclusion in DC is similar to when a pilot doesn’t know how far it is to the runway – we believe they should aim to descend slower and stay in the air longer. Or in financial terms, de-risk more slowly and retain more investment risk.

That way savers hopefully won’t need to switch to economy seats mid-journey, which is their likely reality if they sit in low-risk investments for a long period. There’s actually a whole separate debate to be had about whether it makes sense to de-risk into low-risk investments at all, even without the retirement age uncertainty. Our analysis suggests that where these savings are a big part of someone’s retirement income, then actually low-risk investments in retirement don’t deliver enough growth, particularly given people might live longer than they expect. But that’s a topic for another day.

Of course, we might reach the point in the future where techniques like nudging people, lead to much more accurate target retirement dates. That would be fantastic news, a bit like the fog clearing to reveal a plane’s runaway. But until then, we think the evidence shows we need to stick to reality and avoid over-simplifying the problems people face.

[1] In fact, some glidepaths actually continue to reduce risk after the expected retirement date, though it tends to be gradual