Income drawdown survey: A flexible retirement

Along with this huge opportunity come plenty of problems. Despite huge pushes to encourage more saving for retirement, annuity rates are shockingly poor. More and more retirees are asking themselves why they would want to lock in to a low rate when they could retain investment control in drawdown.

But drawdown is no simple option. Seemingly constant tinkering with the Gad rate for income has seen retirees pushed from pillar to post, moving from 120 per cent to 100 per cent and back again, seeing potentially huge drops in income throughout.

In Money Management’s inaugural drawdown survey, we take a look at more than 50 drawdown providers and ask the key questions: what do they cost? How much of their business is advised? How much income are retirees taking?

Flexible choices

The income drawdown survey was sent out to all the providers we could uncover. Of these, 59 returned the information we requested.

While most of the larger players responded, some notable absentees include Fidelity, who “could not help on this occasion”; JP Morgan, who did not wish to participate; and St James’s Place, which said it did not have the resources to complete it in the time provided.

Seemingly constant tinkering with the Gad rate for income has seen retirees pushed from pillar to post

As Table 1 shows, the vast majority of income drawdown providers come from the self-invested personal pension (Sipp) market – a natural conclusion, since Sipps offer investment control as drawdown does. But a few offer drawdown as a follow-on from a personal pension, as highlighted in the table.

The total number of drawdown customers for all providers featured is 243,439. This includes some of the bigger players, such as Standard Life (45,000 customers) and Scottish Life (33,000 customers). Drawdown assets totalled £38.9bn, an average of almost £160,000 per client.

Over the coming years, it will be possible to identify any trends in the numbers of individuals taking drawdown.

Although some natural attrition is to be expected following deaths, with longer life expectancy, people may remain in drawdown for longer and more clients may choose this route over an annuity.

Some providers have reported that drawdown sales have struggled in recent years. But, with a large amount of wealth heading towards retirement, there is every chance this will turn around.

“Drawdown sales on the whole have declined from previous years,” says Aviva.

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“There are a number of reasons for this, including investment performance, but undoubtedly lower Gad rates have contributed to drawdown being seen by some as a less attractive option than it has been previously.”

All providers offer capped drawdown, but eight do not offer flexible drawdown. This type allows the client to take as much income as they like, as long as they have a secure pension income of £20,000 from other sources. Perhaps surprisingly, some big names do not offer it, including Aviva, Legal & General, Scottish Life and Scottish Widows. Axa Wealth plans to introduce it on its Retirement Wealth Account in the near future.

Price matters

Charges for income drawdown are just as complicated as those for Sipps. As shown in Table 2 (overleaf), costs for starting capped drawdown range from zero from several providers to £330 from Dentons and a time-costed proposition from Mattioli Woods.

But starting costs are only part of the whole equation. Some, such as Scottish Widows, take an all-in approach, where all charges are covered by the retirement account fee. Others, such as LV= and James Hay, charge on a percentage of assets. The right charging structure ultimately depends on the client’s needs.

Charges for flexible drawdown are often higher. Chase de Vere IFA, for example, charges £500 to start up flexible drawdown compared with £150 for capped. It says the higher cost is down to a greater amount of work at outset and, on an ongoing basis, there is a greater risk to the firm as trustees and administrators. Some companies instead have identical charges regardless of whether capped or flexible is chosen.

A focus on cost is rather too narrow, however. Service is absolutely key in drawdown; the whole point is flexibility and control and clients are willing to shell out for good value if they get the right service. Simply choosing the cheapest option is not the right way to find the best fit for a client.

Up and down

The reinstatement of the uplift in drawdown income to a maximum of 120 per cent of Gad from 100 per cent was met with mixed responses. On the whole, the prevailing opinion was that a higher maximum would be positive in a time of low pension income. But the decision by some providers to automatically uplift retirees’ incomes proved controversial.

Table 3 shows the approach providers took regarding the new income limits. A total of eight providers – almost 14 per cent – moved all of their customers drawing 100 per cent to the new

120 per cent limit. The majority (55 per cent) contacted their customers to tell them their options, while 29 per cent took no action, with information to be provided at or prior to the client’s review.

For those who automatically uprated clients to 120 per cent, a logic can be seen: the client opted to draw the ‘maximum’, so when the maximum changed, their limit changed.

But the majority of providers did not agree with this approach. Brian Davidson, platform proposition manager at Alliance Trust Savings, says that since income is taxed, the firm felt it was better for advisers and clients to make a conscious decision to take a higher level of income rather than make any assumptions.

The government announced a full review of Gad rates in the 2013 budget, with an intention to look at “the underlying assumptions used to provide drawdown rates to make sure they continue to reflect the annuity market”. Drawdown providers are hopeful this will prompt a proper investigation into the rates used, which have fallen out of line with annuity rates in recent years.

“Drawdown investors spoke loud and clear about the need for change and it is encouraging that the government appears to be listening,” says Billy Mackay, marketing director at AJ Bell.

“However, there is a danger that the review adopts a ‘lipstick on a pig’ approach and doesn’t deal with the fundamental problem of linking income factors to gilt rates and annuity factors set by the government actuary. The review is an ideal opportunity to break this link and replace it with more simple income limits that give greater certainty to clients.”

Hamid Nawaz-Khan, chief executive of Alltrust, says regularly changing Gad rates is not a robust method. “Comparison with annuity rates is not on a like-for-like basis as life offices use other means to increase their returns on the annuity funds,” he says. “Chopping and changing bases every couple of years helps no one and defeats the objective of keeping costs down.”

Mr Nawaz-Khan makes several suggestions for a more appropriate basis for drawdown income, either independently or as a combination:

• Using a composite yield based on AAA-rated corporate bonds;

• Gad to issue a monthly interest rate based on their assessment of the typical return that may be possible to achieve;

• Increase the minimum return that may be used for calculating drawdown.

There is also the question of gender for drawdown rates. Following the implementation of the gender directive in December 2012, male rates were used as the new unisex rates, meaning a higher rate of income could be drawn by women.

But this is potentially unsustainable; despite the EU ruling on gender equality, women do live longer than men, meaning their pots are more likely to be depleted before death if they are drawing the same amount. The rates are to be reviewed by the government, with Rowanmoor predicting it could lead to a drop in income of up to 5 per cent.

Another issue is that enhanced rates are not available through income drawdown; rates are based on an average, rather than individually underwritten. Some providers, including InvestAcc and Rowanmoor, say better rates should be available for those in ill health.

“Impaired life or enhanced annuities are now commonly used, with a move towards annuities becoming individually underwritten resulting in higher income levels for those with lower life expectancy,” says Robert Graves, head of pensions technical services at Rowanmoor.

“This contrasts with Gad rates that are based on average life expectancy.”

However, as Andrew Tulley at MGM Advantage points out, drawdown is not a pooled concept – the individual risk of allowing greater withdrawals would be far higher for the individual in drawdown than the insurance company offering enhanced annuities.

Tale of two halves

Much of the debate on the maximum Gad rate centred around those taking the greatest income possible. But the idea that the majority of retirees draw the maximum is a myth.

Table 4 shows the percentage of income drawn by advised customers; where the majority of business is non-advised or the data cannot be split, this information is shown instead.

The figures show an interesting pattern: the majority of drawdown clients take the most or the least available. On average, 52 per cent of clients draw no income and 28 per cent draw between 100 and 120 per cent.

The information in the Table covers business as a whole, but it is possible to look a little further at flexible drawdown with data from HMRC. As shown in Graph 1, of the 1,705 individuals using flexible drawdown in the tax year to 5 April 2012, the vast majority – 82 per cent – drew less than £50,000 in income.

Graph 2 breaks this down even further, looking at withdrawals below £100,000. Lower amounts of income are far more popular, with 632 individuals drawing less than £10,000.

Flexible drawdown is only accessible to individuals who meet certain conditions, but can be effective as part of an overall retirement planning strategy. And, having had time to bed in, it has now established a place in the market.

“Flexible drawdown is now getting recognition from those who can meet the minimum income requirement as a serious tax – and estate – planning vehicle, far removed from the ‘take the money and run’ approach which was feared by some commentators at outset,” says Ray Chinn, head of pensions and investments at LV=.

Adding value

Providers are often at pains to emphasise that drawdown should be an advised event. While sophisticated investors will undoubtedly be able to go it alone, for the vast majority of individuals in drawdown, obtaining professional advice throughout retirement is a must.

Table 5 shows the breakdown of advised versus non-advised drawdown business. As shown in the Table, the majority of business for most providers is advised. Of the 49 providers that submitted data, more than half of business is advised for 94 per cent of providers.

Advisers can add value in a number of ways. Selecting the right amount for drawdown – whether in capped or on an ongoing basis for flexible – is key to maintaining a fund throughout retirement. As outlined above, much focus is placed on those taking the maximum, but this is actually not the case for the majority.

“There is no such thing as a safe rate of income withdrawal,” says Andy Leggett, head of business development at Barnett Waddingham Sipp. There is only a rate that is consistent with the client’s objectives, overall circumstances, investment portfolio and the risks they are willing to take.

“If the client’s main concerns are longevity and loss of purchasing power in later years, they may see 100 per cent as unsustainable. By contrast, a client with significant non-pension assets and an overriding concern that they can’t take their money with them when they are gone may see 120 per cent Gad as insufficient and look to flexible drawdown.”

Running on from this, advisers can add value in tax-planning issues around income drawdown. Blended solutions for retirement income are becoming ever more popular, with drawdown, Isas, property and annuities being used to create an overarching solution. Advisers can look at management of income tax and what is most appropriate to draw and when.

Longer lives

This links to the management of funds. If the adviser has already been assisting in the build-up of pension assets, transitioning to an allocation more appropriate for drawdown is a natural step. If picking up a client at the point of retirement, it may be necessary to take a more in-depth look at the existing allocation to determine whether it has been sufficiently de-risked.

The uplift in maximum Gad has already provided an opportunity to work with clients, according to Peter Bradshaw, national accounts director at pension technology firm Selectapension. He says the number of cases analysed by advisers on its income drawdown calculator rose by 40 per cent in March and April compared with January and February this year.

Although drawdown limits take no account of health, as enhanced annuities do, an adviser can still compare the date of retirement with projected life expectancy and demands of retirement. Some individuals are already looking at up to 30 years in retirement; shifting everything into cash at the age of 55 is highly unlikely to produce a sustainable income for such a long time. Balancing the risk with the need for investment growth to avoid depleting the pot is a key area for adding value.

There is also a conversation to be had with clients on what will happen to their drawdown assets when they die. In April 2011, the requirement to annuitise before the age of 75 was removed. Along with this came an agreement that any assets remaining in an individual’s pension could be inherited upon death, subject to a 55 per cent tax charge, designed to recover the tax relief given on the way in.

Discussions with clients on this point are absolutely vital. Do they view it as a 55 per cent charge, or a 45 per cent return of an asset they would have kissed goodbye to had they purchased an annuity?

But there is a risk of retirees looking to avoid the potential loss of an annuity and inappropriately entering into drawdown, according to Dentons.

“It must be properly understood and advised upon,” says Martin Tilley, director of technical services at the firm. “Getting 45 per cent of the pot back on member/spouse death might prove to be too tempting and pull into drawdown some clients whose fund is of a size where it might not be economical to run.

“Total returns from inappropriate drawdown and sums on death might be lower than those payable from a simple conventional or impaired-life annuity.”

Some providers still require clients to annuitise at 75, so it is worth checking the terms of any contract if the client wishes to stay in drawdown indefinitely.

There are multiple opportunities for advisers to assist clients with income drawdown. For many clients, retirement is the first point of contact they will have with an adviser; providing a robust, ongoing service is a strong way of keeping that client on the books for many years to come.