Guest Spot: Funding retirement income – The liquidity illusion

  • Author : Just
  • Date : 9 Nov 2020

In this Guest Spot Just cover balancing the three key moving parts in the retirement equation – longevity, inflation and investment returns.

Creating and managing a regular flow of ‘income’ from a diversified portfolio has been described by Bill Sharpe (he of ‘Sharpe Ratio’ fame) as the “nastiest, hardest problem in finance” and he has a point.

Balancing the three key moving parts in the retirement equation – longevity, inflation and investment returns – and achieving the optimal journey for the retiree, is something that has occupied some extremely bright minds for a few decades now.

The preferred approach to this conundrum from within the UK financial planning community is currently to rely almost exclusively on fairly traditional diversified portfolios of stocks, bonds, and maybe some alternatives, along with some property exposure and an element of cash. The hope is this approach will deliver sufficient returns to deal with the spectre of inflation, and when it comes to the third horseman of the apocalypse, longevity, this risk is typically being self-insured. This preference to self-insure longevity is often put down to a desire by both the client and the adviser to maintain liquidity for legacy provision, or in case there are unexpected future events. But is this liquidity real or an illusion?

Turning to another leading thinker, Wade Pfau (Ph.D), a pre-eminent retirement planning researcher from the US. Pfau, who has published copious papers on the subject, suggests that true liquidity within a retirement portfolio only exists to the extent that there are free assets not allocated to support withdrawals scheduled over the expected length of retirement. In other words, if all the portfolio is needed to support the retiree’s lifestyle, the fact that the client has £1m invested does not mean they have £1m of liquidity, it’s an illusion! According to Pfau:

This lack of true liquidity is heightened when longevity is being self-insured. To effectively manage the risk of the client outliving their assets, a planner should structure withdrawals for a period of time well in excess of average life expectancy (or 50% survival probability). This could lead to a retirement planning period of 35 years or more for someone living off their assets from age 65.

To provide a practical example, let’s imagine a relatively balanced risk male retiree who is age 65 and requires an income of £30,000 throughout his retirement. This may not represent all of his income requirements but for our purposes let’s just focus on the £30,000. Using planning software you can calculate that to provide this level of income to the point where the client has a survival probability of just 10% (that’s a 90% likelihood that they will be dead) would require the client to allocate £1.220m* of their assets to support this spending until age 99. This equates to a withdrawal rate of 2.46% of the initial £1.220m capital base. So if the client had a £1.5m portfolio he would have only £280,000 of liquidity. Can we improve on this and create greater liquidity?

Incorporating risk pooling into the client’s portfolio, improves liquidity, as the cost of guaranteed income for life solutions is based on the average longevity of a large cohort of individuals rather than a planning assumption made for an individual client. At current rates, the cost of securing the same £30,000 of income for life using risk pooling would use £653,153** of the clients portfolio, increasing liquidity to £846,847.

Novia platform users have exclusive access to the innovative guaranteed income for life solution, Secure Lifetime Income (“SLI”). SLI sits within the SIPP, on platform and you can read more about it here.

There are other benefits to incorporating risk pooling into a retirees plan when a contemporary solution such as Secure Lifetime Income is viewed as part of an overall retirement portfolio, such as long term improvements to portfolio sustainability and increased legacy provision and we will explore these in other articles but let’s finish this one with a few words from Wade Pfau…

“any form of risk pooling can help manage longevity risk more effectively than reliance on an investments only strategy” ***

If you’d like to find out more about the Guaranteed Income option on the Novia Platform, please speak to your Novia Regional Sales Manager.



* assumptions

  • Balanced 60% Equity/40% Bond portfolio
  • 1.50% recurring fees (platform/investment/ongoing advice)
  • Gross/no allowance for tax]

**Guaranteed Income for Life quote assumptions (SLI):

  • Single life
  • Level, no escalation
  • Fit and healthy

*** Quote from Page 312 of his book:

“Safety-First Retirement Planning – An Integrated Approach for a Worry-Free Retirement”

Wade Pfau, Ph.D. / CFA / RICP

The statements and opinions expressed in the Guest Spot are those of the author and do not necessarily reflect those of Novia Financial plc or any of its employees. The company does not take any responsibility for the views of the author. Any links, web pages and documentation within the Guest Spot are provided by pages maintained by independent third parties and Novia accepts no responsibility for the availability, content or use of the information contained within them.

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