Since George Osborne announced his radical shake-up of the pensions system in March 2014, allowing savers greater flexibility in how they access their pension fund assets, annuity sales have seen a dramatic decline while appetite for income drawdown has been on the rise.
For example, FTSE 100 life insurer Legal & General recently reported a 61 per cent decline in sales of individual annuities since the introduction of the new pension freedoms, compared to the same period in the previous year. If the experience of Australia in the wake of its own comparable pension reforms two decades ago is anything to go by, annuity sales could see a further contraction: Australian annuity purchases dwindled to around 4 per cent of their pre-liberalisation level.
While there has been a lot of focus in the media in the run up to the introduction of reforms on the cashing in of pension assets, with concerns over the potential use of retirement funds for holidays and luxury items, to date the evidence suggests that the sums of money being withdrawn from pensions are modest.
It is of course early days but data collected by the FCA six months in to the new regime found that 82 per cent of uncrystallised fund pension lump sum withdrawals were in respect of pension funds of less than £30,000. Encashment of small pots might make sense for those using these assets to clear debts and mortgages.
While widespread cashing up of larger pensions has not emerged, what has proved a major phenomenon from the reforms has been exponential growth in income drawdown, which has provided a further boost to the Sipp market both through advisers and execution-only platforms.
As financial advisers across the UK will understand, this general shift away from the certainty of a guaranteed income for life in favour of income drawdown is no panacea. It also carries much greater risk for savers that they will exhaust their retirement pots too soon.
Yet, alarmingly, many are going down the drawdown route without advice and in years to come, I fear there will be more horror stories in the weekend press about those left in dire straits in retirement through poor investment decisions than tales of those who blew their retirement resources on sports cars and holidays.
Countless studies have repeatedly shown that most people woefully underestimate the scale of the financial resources they will need to adequately finance their retirement, with a recent study by BlackRock indicating that those aged 25 to 34 years were on average miscalculating the pension pot they will need at retirement by £373,000.
Much of this is down to savers underestimating their life expectancy, basing it around those of close relatives such as parents and grandparents and not fully comprehending the significant improvements in UK life expectancy that have arisen from advances in medical science and improved healthcare. While most of us would agree that improved life expectancy is good news, longevity risk is one of the biggest financial hurdles facing UK savers.
As more and more of us choose income drawdown as the cornerstone of our retirement strategy, the need for ongoing financial planning and an accompanying bespoke investment strategy has never been more important given the real risks that savers face in exhausting their funds too rapidly.
Those contemplating drawdown should only do so with an understanding of their future cashflow requirements and a realistic appraisal of whether their assets will be sufficient to meet these needs and an investment strategy that falls into place to support this. This is where the combination of an expert financial planner supported by professional investment manager, can prove so effective in ensuring the client achieves a financially secure retirement. It is clear that many financial advisers are adopting this model, with research firm Defaqto reporting a 27 per cent increase in the use of discretionary fund managers in the 12 months to April 2015.
This refocusing of many adviser businesses around financial planning while outsourcing investment management through use of both discretionary managers and off-the-shelf multi-asset funds of course pre-dates the pension reforms. It is one which has progressively gathered momentum over several years fuelled in part by the increased regulatory focus on ongoing suitability and therefore the need to regularly rebalance a portfolio to prevent it drifting into a different risk category. But this trend towards outsourcing investment management is also indicative of the greater professionalism in the industry. The skill sets and technical knowledge of a financial planner and an investment manager are clearly very different but together a two-expert approach is a powerful combination.
This approach is also a boon to an adviser’s time, a factor that should not be underestimated. With advisers stretched because of client demand, something that looks set to be exacerbated further with the imminent onset of MiFID II, outsourcing the time consuming process of investment management frees up valuable man hours with which advisers can focus on the meat and drink of their work.
Two-way communication is pivotal to a successful relationship between a financial adviser and his DFM partner. Of utmost importance from the outset is to develop a clear understanding about the client’s future cash flow requirements, as this will be absolutely key to ensuring the portfolio is managed accordingly with an appropriate level of risk and that a robust asset allocation strategy is put in place to deliver on these needs. In particular, it is important to plan liquidity carefully around future cash flow requirements, with sufficient assets held in cash or near cash instruments to prudently cover near to medium term requirements.
But it is also vitally important to have an ongoing dialogue because no matter how well designed a plan is at the outset circumstances will inevitably change of time. Good financial advisers know their clients incredibly well and will recognise the financial significance of important changes in the client’s personal circumstances that will have knock-on impacts on their financial plan and potentially require an adaptation to their investment strategy. These might include receipt of a financial windfall such as an inheritance or the downsizing of a property, a change in their health circumstances that might require a reassessment of their life expectancy, the death of a dependant or a divorce.
Likewise, it is imperative that a DFM keeps their financial adviser partners well informed with their views on market outlook and tactical portfolio positioning so that the advisers remain at the apex of the client relationship. When an adviser uses an outsourced investment solution, they do not want to be disintermediated from the process but kept in the loop and suitably empowered when meeting with their clients.
It is clearly vital that when major events impact investment markets the adviser understands the impact on the size of their client’s assets or yield profile of their retirement fund, as this could in stressed market conditions require a reassessment of the level of income they are drawing. The true value of outsourcing to a DFM investment manager lies in the benefits bought to both the adviser and the client, benefits which are clearly intrinsically linked.
Mark Coles is director, financial intermediaries at Tilney for Intermediaries, the discretionary fund manager
Key points
There has been exponential growth in income drawdown since pension freedoms.
There has been a refocusing of many adviser businesses around financial planning while outsourcing investment management.
Two-way communication is pivotal to a successful relationship between a financial adviser and his DFM partner
