Blended retirement solution means using a range of products to provide an income by combining security with investment potential – blending the best of an annuity and drawdown.
But a more holistic view of an individual’s income options and needs in retirement lends itself to taking a much broader perspective that would see all of the various options to boost net income placed into one model.
Such a model should attempt to respond to the key risks facing consumers in retirement, which have largely transferred from providers to clients and their advisers.
At a basic level there are four key risks that need to be considered:
• People are simply living longer. As a result, they must ensure their pot provides a sufficient income over retirement periods stretching over three decades.
• Inflation risk is present in that money tends to devalue over time.
• Less obvious is the issue of flexibility, or rather ‘inflexibility’. This is the risk that a financial plan does not respond to changing needs over the course of a retirement, such as any requirement to pay for long-term care that may arise.
• Finally there is volatility. This is particularly relevant for funds remaining invested and subject to market movements.
Hierarchy of needs
One model which can be used to determine at-retirement choices in the context of these risks was set out by management consultancy Milliman along with Axa Wealth. It is based on US psychologist Abraham Maslow’s famous ‘Hierarchy of Needs’, which placed people’s innate requirements in order of priority to ensure psychological health. Axa Wealth transposed this hierarchy on to retirement spending ‘priorities’, to differentiate between essential and more discretionary costs.
In the retirement hierarchy, the money set aside to feed oneself, pay for a roof over your head and meet essential bills is defined as ‘essential’. Income to meet these needs would be subject to a very low attitude to risk.
More ‘discretionary’ spending, which could include everything from running a car to holidays, is less set in stone and so open to greater risk. Often objectives here might require significant investment growth to be fully realised.
The more important given needs are considered, the less risk your client will be willing to take. This could result in possibly several layers of risk needing to be met.
A final element is ‘legacy’, or the wealth your client may wish to pass on when they die. This is classified as the most aspirational of the needs and thus subject to the highest risk.
Once ranked, these income requirements can be placed into a framework.
The vehicles
Essential costs would be met largely through risk-free guaranteed income. This could mean the state pension, annuities, defined benefit pension rights, or a predetermined income through equity released from a property.
Meeting discretionary spending needs is where the invested element of the pot is relevant. Depending on the levels of risk the client is able to take, the portfolio would be suitably diversified to obtain necessary growth while exposed to the least amount of risk.
It would include both income-based and capital growth investments and everything from cash at one end of the spectrum to meet short-term requirements, through fixed income, and on to equities of various types at the other.
In some cases, it may be appropriate to use established multi-asset vehicles, effectively outsourcing the investment management function.
As well as assets held inside a pension wrapper, some of this element could be taken up by assets outside of the pension environment, including money liberated from a pension.
Passing it on
Finally there is the longer-term legacy need, which is where the riskiest equities with the strongest returns potential come into play. These legacy issues are defined as ‘optional’ and sit outside of the four risks outlined earlier.
In addition to all of this, advisers and clients will want to consider planning for potential needs later in retirement. As well as long-term care, concern has also been raised about people losing their ability to make decisions as time goes on.
Pension minister Steve Webb has proposed ‘default’ annuity-type solutions, which would be available early on in retirement and could perhaps be folded into ‘guaranteed’ or ‘essential’ income needs, simply being deferred until needed.
Also ‘Longevity insurance’ products, typically based on variable annuities, are already popular in America. A number of insurers, including Legal & General and Partnership, have expressed interest in bringing such products to market here, while others such as Metlife achieve big sales on the other side of the pond.
However, annuities have under-delivered in recent years. Increased longevity has stretched retirement periods to 20, 30 years and beyond. Rates are low and retirees’ collective reluctance to shop around and exercise the open market option has seen the perception of the products sink lower. As such, the problem of a tainted annuities brand remains, and could present a hurdle to overcome.
