By categorising income withdrawal sustainability ‘scores’ into different bands, explains Lorna Blyth, advisers can help clients understand what good and bad levels of withdrawal look like.
One concern associated with the introduction of the pension freedoms is that people could make significant withdrawals of income, which would not be sustainable in the long term. We are seeing more people than ever before using income drawdown with the result that retirement planning accounts for an increasing slice of an adviser’s business income.
Discussing how their clients are able to sustain a reasonable level of income is a key conversation – though by no means a straightforward one, as it involves an understanding and flexibility of the risks and trade-offs that may need to be made.
Using a ‘4% withdrawal rate’ is often cited as a good starting point but it is a broad rule of thumb and, once you factor in individual client circumstances, investment strategy and fees, it can look quite different. The heat map below shows just how sustainability scores for different withdrawal rates and different terms vary.
By categorising the sustainability scores into different bands, advisers can help clients to understand what good and bad levels of withdrawal looks like.
As an example, Royal London believes a score of 85% or more is highly sustainable, because it means that 85% of the time the customer will achieve this level of income or more and then 15% of the time the customer may achieve less income.
Over all terms, a withdrawal rate of 4% is reasonably sustainable while, over a 15-year term, a 6% withdrawal rate is highly sustainable. Where it starts to get interesting is with withdrawal rates of between 4% and 6%.
As the term increases beyond 15 years, a 6% withdrawal rate quickly becomes unsustainable. This is useful to show how term and income withdrawal rates impact sustainability and can be a good starting point for client discussions.
Individual client circumstances
More specific example are possible, however, which show sustainable income levels that are based on individual client circumstances. These examples take into account how much has been saved, the level of desired income, how long the income is to last, the investment strategy and charges.
Using this stochastic projection of the probability of achieving the desired income level over the term required, advisers are able to manage client expectations of viable and sustainable income withdrawal rates, which should then avoid those nasty surprises.
Quarterly reviews, using Royal London’s unique Drawdown Governance Service, which tracks client scores, also means the risk of a client running out of money can be readily identified and remedial measures put in place to keep a client on track or, where necessary, reset their objectives.
What is clear is there is not a one-size-fits-all solution. Regular reviews and active management of a client’s evolving needs and income requirements by advisers will highlight the need for even the smallest adjustments.
Lorna Blyth is pensions investment strategy manager at Royal London
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