Following the pension freedom reforms, writes Bob Champion, the new retirement income industry is merely in its infancy and everyone involved will have to learn how to deal with a raft of consumer demands.
In the latest adviser newsletter from Retirement Advantage, the firm’s pensions technical director, Andrew Tully, questions the use of safe withdrawal rates. He mentions the 4% rule that originated in the US in the 1990s and references more recent research from Morningstar, which indicates the equivalent rate would be in the range of 2.5 to 3%.
Andrew quite correctly points out a number of reasons why such research is informative but not appropriate when planning for individual consumers – not least, spending patterns in retirement will not usually follow an inflation-linked straight line.
In June of this year, Platforum produced an adviser survey that found fewer than 50% of financial advisers use long-term cashflow planning tools with the majority of their clients in or at retirement.
By now we should have moved on from defined benefit thinking. A pension was an amount of deferred pay an employee should be grateful for and they should adjust their standard of living to the amount provided by a philanthropic employer. When they move into retirement, a majority will have the energy to enjoy their 52-week-a-year holiday, with spending demands that may stretch their retirement saving.
This is why cashflow planning tools are important. They demonstrate to consumers the probable consequences of their actions – not least when the holiday may come to an involuntary end. Various spending patterns can be put in front of the consumer so they understand the consequences of their actions.
The pension freedom reforms recognised that not everyone has sufficient pension savings to convert into a lifetime income that is meaningful. Cashflow modelling tools that can take into account other savings and investments therefore add value for the consumer. Alternatively a consumer may be interested in leaving much of their pension savings on their death as a tax-efficient bequest to their nominated beneficiaries.
Discussions could therefore be had on the following questions:
* What is the best way to make pension savings last while drawing down a reasonable income?
* From where can a client draw income once their pension savings have been used?
* Alternatively, from where can they draw income to preserve the maximum pension savings?
Cashflow planning tools could help with all of these discussions, although I am not aware of one that includes drawing down on the residential home.
Solutions denied
I am disappointed the secondary annuity market will not now come into being – although I can well understand the consumer protection issues and the difficulties annuity providers would have faced.
Looking at the position of the retired consumer, some are income-rich and asset-poor. Others may wish to accelerate their pension income and depend on their home or other means in their final years of retirement. Another group may want to slow their pension income to leave pension bequests on their death. These consumers have been denied solutions that would have appealed to them.
In my opinion, the wrong approach was taken by focusing on the annuity product. What has value to investors is the longevity-linked income stream. I believe the solution lies in making it possible to receive a lump sum from a licensed pension income trader in return for the pension income payments. The lump sum could be paid to another retirement income provider or retained by the consumer themselves.
As part of the contract with the licensed trader, the annuitant would supply an irrevocable direct debit to ensure the income stream was passed to the trader as it was received. The income trader would claim any income tax deducted directly from HMRC, thereby producing the gross income for the trader.
The annuity product would remain as is but the income stream would be contractually passed on to the income trader. This solution could also be applicable to defined benefit pensions.
Following the pension freedom reforms, I believe the new retirement income industry is in its infancy. We all have to learn how to deal with the many ‘I want’ demands from consumers who, as they learn to use the freedoms they now have, can be adapted to the lifestyles they want or need.
This means more flexibility will have to be introduced but, what is more, they will want to visualise what certain actions could mean for them which will add to the importance of cashflow planning tools.
Bob Champion is chairman of the Later Life Academy
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