Steven Cameron talks through the type of client who would be best suited to blended retirement income solutions.
Last month marked two full years since pension freedom arrived in the UK, and as the dust begins to settle we are beginning to get a real sense of how the new retirement income market is taking shape.
The latest figures from the Financial Conduct Authority (FCA) suggest that in Q3 2016, demand for flexi-access drawdown was twice as high as demand for annuities.
More than 41,000 people entered a drawdown policy compared to just over 20,500 opting for a guaranteed lifetime income (see Fig. 1, below).
Clearly, people are choosing to make the most of the newfound freedom and welcome the flexibility to both access cash and vary income to suit their particular needs.
Risk element
There is, however, no escaping the fact that this greater freedom has also introduced an element of risk to retirement planning. Without proper preparation and advice, this could threaten to leave people with little or no income to carry them through their later years.
These risks come in all shapes and sizes. Lower mortality is leading to longer life expectancies, market volatility introduces heightened investment risk for those drawing income during a market downturn, and even underspending in early retirement presents a risk of sorts for those trying to get the most out of their life savings.
All together, these risks mean that, for all its benefits, flexi-access drawdown isn’t right for everyone. Deciding how to create the right retirement income, an income that may have to last 30 years or longer, is a complicated decision.
Considerations
When helping clients navigate the options available, it is important advisers consider carefully a client’s attitude to risk and capacity for loss and keep an eye out for any personal circumstances that suggest naked drawdown may leave them too exposed.
First to consider is attitude to investment risk. This is the level of risk a client is willing to take and includes the funds and asset classes they are comfortable investing in, the weighting of each of these, and how much of their pot they are willing to invest in potentially higher risk areas.
Drawdown is one retirement income option. But whether people choose an advised or a non-advised drawdown option, there is a risk in investing in funds which overly expose them to market falls.
If these come early on in retirement, then this can have a significant impact on a retiree’s income for the rest of their life.
Capacity for loss, a slightly different calculation, factors in any supporting assets that could be relied on should market falls hit the value of pot significantly.
This is described by the FCA as “the customer’s ability to absorb falls in the value of their investment and if any loss of capital would have a materially detrimental effect on their standard of living”. It forms an important part of any retirement income decision.
People with significant assets outside their pension – such as a considerable ISA pot, a house they could downsize, or even an art or antique collection they could liquidate – may have a greater capacity for loss than those solely depending on their pension.
Guarantees
If someone has a relatively high risk appetite, but simply cannot afford to make any losses to their base income level, then this should ring alarm bells for anyone considering drawdown. In all likelihood, these clients would be best off with a guaranteed income for life, be that through an annuity, or a best of both solution such as drawdown with guarantees.
Any guarantees are based on the ability of the issuing company to pay them. If, for example, the company no longer existed, then the guarantees it provides would be affected.
Independent consultancy the lang cat concluded that drawdown with guarantees should be brought into all conversations between advisers and their clients as an alternative to both annuities and drawdown blending the upsides of both, and at least as part of a retirement income portfolio.
As a third way, drawdown with guarantees is emerging as a highly flexible solution that not only provides a guaranteed income but as retirees are still invested in the market, the potential to benefit from any market growth.
Increased choice
The retirement income landscape has changed dramatically over the past two years and it is encouraging to see people taking advantage of pension freedom.
But now more than ever, choices made about retirement income could have far-reaching implications that are not truly felt for some 10 or 20 years.
One thing is certain: “set it and forget it” strategies are no longer suitable for navigating changing needs throughout retirement, and it is crucial that regular reviews and assessments form the basis of later life advice.
As circumstances change, so should recommendations about the most appropriate level of income. And if it becomes clear that naked drawdown is leaving a client too exposed, it is never too late to revisit the conversation around guaranteed income.
Steven Cameron is pensions director at Aegon
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