Today’s clients need to more fully understand the range of solutions to ensure a better chance of a decent income when they finish working.
For independent financial advisers involved in the fiercely competitive at-retirement market these are difficult times, with the lowest-ever annuity rates making it extremely difficult for them to know how best to serve the needs of clients, according to the Prudential’s Vince Smith-Hughes.
The company’s head of business development believes it’s as challenging to put together viable solutions for those approaching retirement as it is for those that are currently within income drawdown and struggling to maintain the desired income level.
“It’s a tough time for advisers who are faced with a number of choices,” he says. “They can choose to leave clients in drawdown; move them into other funds, such as those offering guarantees; or switch into some form of annuity. Each route has its positives and negatives.”
For example, if they decided to stick with drawdown, the client would have to be made aware of the potential downsides of maintaining existing income levels - which is basically that both their fund and future income are likely to be significantly eroded.
Basically, it all comes down to the type – and amount – of risk that a client is prepared to take, points out Smith-Hughes, who is adamant that everyone will have to accept some potential downside unless they have a multi-million pound pension pot and can buy an RPI-linked annuity, giving them the starting income they need.
“If advisers speak to clients about all the risks that exist – including dependency risk that looks at what would happen if they died – then more of them would understand the need to accept and perhaps trade risk,” he suggests. “They just need to be taken through the various possibilities.”
For example, should they opt for a level annuity, they’d need to know the risks that will be posed by inflation rather than any investments. Conversely, buying drawdown in its traditional form would mean accepting investment risk in exchange for diluting the longer-term effects of inflation.
“Virtually everyone has to accept some sort of risk but they need to know what those risks are and then they can decide if they’re happy putting all their risk eggs in one basket,” he says. “An option could be middle market products which strike a balance between inflation and investment risk.”
It’s a key development. Over the last couple of years a number of retirement specialists have been suggesting ways of combining various solutions to meet the needs of particular clients. This is a trend which Smith-Hughes believes will become a permanent part of an adviser’s armoury.
“People no longer need to choose one product because mixing and matching is becoming popular,” he says. “I’m a really big fan of this approach because it means skilled advisers are able to look at all the risks on the table and then suggest products that offer the best possible bespoke solution.”
While acknowledging the specialists in this area are slightly ahead of the rest of the pack, Smith-Hughes is confident that the entire market will eventually follow, especially if the introduction of the Retail Distribution Review succeeds in encouraging a greater degree of specialism.
He cites the long-held view that income drawdown wouldn’t be a viable option unless an individual had a pension pot of at least £100,000, arguing that modern day financial advisers cannot look at this subject in such simplistic terms.
“You could have a multi-millionaire with a pension fund of £50,000, in which case it could be entirely appropriate for them to go into drawdown,” he says. “However, you may have someone with total wealth of £250,000, all in their pension fund, in which case drawdown might not be suitable.”
The fact is that advisers are increasingly reporting back that their clients are surprised and disappointed by the amount of income their pension pots can provide. In many cases this means they will need to consider alternative solutions to generate the money needed to survive.
“People are no longer retiring in order to sit in front of the television – they are far more active, have numerous hobbies and go on all sorts of holidays,” he adds. “The combination of their changing retirement habits and the impact of lower annuity rates mean they will continue to seek different types of solutions.”
Prudential believes its Income Choice Annuity is certainly worthy of consideration, especially for individuals that are prepared to take an element of investment risk in order to counteract the effects of inflation and give themselves a chance of a better income – both initially and over the long-term.
Vince Smith-Hughes explains that “on average, someone aged 65 can expect to live for about another 20 years but the income from many annuities will never increase and this could badly affect them financially. Two decades without any income growth – coupled with rising inflation – is likely to result in thousands of clients facing a very difficult retirement.”
Prudential’s Income Choice Annuity, therefore, helps beat the impact of inflation by being linked to the performance of its With-Profits fund. However, while this gives an adviser’s clients the opportunity to enjoy rising income, it must also be pointed out that levels can fall.
“The Income Choice Annuity guarantees to provide their clients with a regular income, usually for life, as well as the reassurance of a secure level of income, which is an amount we guarantee to pay their clients, regardless of how the With-Profits fund actually performs,” he explains.
Another key benefit is the choice of starting income, and the flexibility to change this level throughout retirement. Clients can decide initial amount from within a set range, after which it can normally be changed once every two years from the second policy anniversary.
“This means it can adapt to their clients’ needs as they change through retirement,” he adds. “It means they can change the level of income in the future if they so desire which gives them a tremendous amount of flexibility.”
As well as looking at the potential benefits of such products, advisers and their clients are also focused on the worst case scenarios, particularly given the fact they have watched the collapse of a lot of financial institutions and, in many cases, the halving of investment returns.
“For a 65-year-old the guarantee offered is about three quarters of what they could get with the best in market conventional annuity,” he explains. “I would obviously expect that it would never fall this low but as an absolute surety it certainly gives people some comfort.”
Of course, a hurdle in some eyes will be the term “With-Profits”. However, Smith-Hughes believes the doubters should focus on how Prudential has done down the years rather than being influenced by the returns generated by some of its poorer performing rivals.
“Our With-Profits fund has a very good history of delivering required incomes for clients for more than 20 years,” he says. “The Income Choice Annuity is simply an evolution of this approach and one that people really can’t afford to ignore as it can look so much more attractive than conventional choices.”
Advisers that choose Prudential as a partner will also be buying into its experience and knowledge of the industry. “The company is a very serious player in the retirement market and very heavily develops products like Income Choice to make them as fit for purpose as possible. Since this contract has been available – coming up to three years – everyone in it has seen their income increase.”
However, a worrying fact is that the market doesn’t seem to be embracing the changing dynamics of the retirement world quickly enough. Too many advisers only recommend annuities or drawdown and don’t consider anything in between, according to Smith-Hughes.
“That’s just too simplistic these days,” he says. “The retirement specialists have been leading the way by offering a smorgasbord of products and that’s definitely the way forward. Advisers should also be helping to educate their clients about the possible solutions.”
One way to do this, he suggests, is through scheduling regular updates and sending them information well before key decisions have to be made. Top of the list of priorities will be establishing what they need from their savings and how much they require for a decent pension.
“They need to understand what they can do with their funds, the options they have and the various risks they must consider,” he adds. “It means they will be a bit better prepared when the time comes to sit down and make decisions that will affect their longer-term income.”
So what about the future? Mr Smith-Hughes argues advisers that have traditionally focused their energy on recommending either traditional annuities or income drawdown, consider solutions such as Income Choice Annuity as part of an alternative suite of retirement solutions.
“It can provide a higher, more sustainable income than drawdown, and one that can keep pace with people’s changing circumstances,” he says. “It may not suit everyone but those benefits – coupled with a pretty attractive guarantee – means it will tick the boxes for a lot of clients.
Vince Smith-Hughes, head of business development at Prudential www.prudential.co.uk/
