As pensioners turn away from annuities, towards drawdown and other alternatives ,they will surely need more ongoing financial advice, so the argument goes. A potential cloud to spoil this otherwise sunny picture could come in the form of in-house income drawdown services offered by pension providers.
Instead of members of occupational defined contribution schemes being pushed into the open retail market, schemes may instead offer their own form of drawdown solution. This, at least, was the idea proposed by Teresa Fritz, consumer advice consultant at the Financial Services Consumer Panel (FSCP), who suggests that this would be better for members than leaving them at the mercy of retail market options. So is this a real threat or should IFAs start gearing up for a flurry in retirement business?
In-house threat
The government has proposed that pensioners be allowed to have greater freedom over their defined contribution pension savings. The concern that the FSCP and other consumer groups have expressed following the rule changes is that poor decisions taken with this freedom could leave them worse off than with an annuity. Given that the new rules – which are still at the consultation phase and have not been finalised – include permitting 100 per cent of a pension to be taken as cash lump sum (of which only 25 per cent would be tax free, as was previously the case), the understandable worry is that the money could be used to buy risky investments – or just spent. If pensioners are presented with a drawdown service by their own provider – or company in the case of an occupational scheme – this problem could be avoided. But with flexibility around drawdown increasing, one-to-one financial planning advice would still be required, as the government has recognised with the proposal that individual guidance becomes mandatory.
With more choice comes more responsibility – and the need for more help. If pensioners opt for drawdown, rather than taking the cash and investing it in conventional savings products, from next year onwards they could take up to 150 per cent of GAD rates per year in income – which would amount to 4.5 per cent at current rates.
If they have £12,000 of guaranteed income from elsewhere, then even this restriction is limited. Occupational schemes which offer an in-house drawdown option will have to take great care to ensure members understand how to balance risk and income levels. They should also consider all the options available to them – not just drawdown.
As advisers know, this can only be done with proper, individual, face-to-face advice, involving cash flow planning. This will mean greater demand for adviser’s services, not less, as weighing up all the options is not straight forward.
Exploring the options
IFAs have been advising on drawdown for many years, but how does the lifting of GAD restrictions and the option to take a 100 per cent cash lump sum, change retirement advice? Table 1 illustrate a range of options that would be available to a pensioner with a £1m retirement pot – some of which have not been available before.
The scenarios here include a typical drawdown arrangement (Plan A), investing in a 50/50 equity/bond portfolio, taking 150 per cent of GAD (Government Actuary Department) income – 4.5 per cent – and assuming a modest 3.5 per cent annual return.
Plan B is a 5.6 per cent annuity – which is broadly the rate available on a single life level annuity for 65-year-old male at the time of writing.
Plan C involves making use of the option to take all the money as cash, and then reinvesting the proceeds in a long-term bank account at 3 per cent pa, withdrawing an additional 3 per cent pa as income: the difficulty being that the client has to pay £150,000 in tax on outset (20 per cent of £750,000).
Plan D makes use of the lower limit on flexible drawdown. By spending £214,285 to buy a £12,000 guaranteed income in the form of a 5.6 per cent annuity; this qualifies him for flexible drawdown. Our hypothetical pensioner then invests the remainder in a 50/50 portfolio of shares/bonds but this time takes 7 per cent income – way over the GAD limits for capped drawdown.
As can be seen from the graphics, an annuity is by no means off the table. Offering a fixed £56,000 a year income for life is a very competitive rate: the downside is that it leaves zero to be inherited. While Plan D offers a higher income rate than an annuity for the first seven years, it soon trails off as the pot diminishes until it nearly runs out at age 95.
Plans A and C maintain a good bank of capital at age 95, but income levels are much lower. Of course, with both Plans A and D, investment returns could be much better, or worse, than this model predicts, while B is fixed,
and C could pick up a little if interest rates change. Being able to see such a range of options is without doubt a benefit for pensioners, but unless they are able to perform scenario planning, it is very difficult to understand the impact – and relative merits – of all available options: comparisons between different types of product are tricky.
No-one likes making an irreversible decision, which is the most unappealing aspect of an annuity. Although on these models other options may not look entirely compelling, the advantage is that the pensioner is not locked in for life – plans can change as circumstances change. If interest rates rise then annuities may be much more compelling in future, as might savings accounts.
In order to properly explore all options, clients will need a considerable amount of professional hand-holding, not just on outset but to review and potentially alter the plan as times change.
Gearing up
It is important to remember the changes announced in the Budget are draft form only: the details will be determined over the coming months with a view to being introduced in April 2015. IFAs need to pay attention to the shifting sands and keep their clients in the loop.
But with all the recent publicity surrounding it, it is not be a bad time to promote retirement planning services. That involves researching all available products and scenario options, and preparing pre-set propositions that may appeal to different categories of clients, depending on circumstance.
For the laymen, retirement planning is already complicated enough – this is why so many simply throw their hands up and buy the first annuity they are offered.
In the brave new world, everything is about to get a lot more confusing for them, and they need reassurance that help they can trust is on hand.
Bob Campion is head of international business for Charles Stanley Pan Asset
