There have been few chancellors in living memory who have made an announcement with such impact and far-reaching consequences as George Osborne’s 2014 Budget.
The radical overhaul to the way people access their pensions – which effectively ended the requirement for UK pensioners to purchase an annuity or enter into some form of income drawdown arrangement – was the most drastic change since the state pension was introduced in 1908.
With just over a month to go before the new pension rules and freedoms come into effect, this article explores some of the thinking around building a retirement portfolio after April.
Axa Wealth, the wealth management provider, identified that the products of yesteryear will increasingly be combined with innovative solutions to create personalised retirement portfolios going forward, then commissioned Milliman and worked closely with us to produce a detailed report on the subject, entitled “Retirement planning: Bespoke retirement solutions are ‘the new black’ in 2015”.
This report presents a retirement framework which will help advisers and their customers to assess their needs, and provides analysis and commentary on the key issues of financial planning as a result of the forthcoming pension changes. We have drawn from the report in writing this article.
For most people, limited financial resources mean that tough choices will need to be made to help them achieve their retirement goals. But for all entering into this new world, we need to absorb the following key messages:
• Post-retirement risks are different from pre-retirement risks, and this will become more important after April 2015.
• Responsibility and therefore risk has now been passed fully to the individual.
• Individuals will need more support from their advisers to help navigate their way through retirement.
• Existing products and solutions need to evolve to meet the new needs, and innovation can therefore be expected.
As retirement approaches and the individual’s financial capital grows, that individual’s risk exposure changes and the new priority of protecting their accumulated assets becomes uppermost. Unlike in the earlier life stages, when there is still time to recover from market downturns, at this stage of their lives the ability to replace lost savings through salary is reduced as they are unlikely to re-enter the workforce and there is limited time to recapture capital losses through waiting for investments to recover. This is when individuals might look at strategies that provide some form of guarantee against financial loss in order to protect their retirement income streams.
For the past 100 years, retirement risk has been managed by focusing on longevity through the ‘compulsion’ of annuities and the setting of maximum income levels from drawdown contracts. The Budget changes remove this established, but arguably simple, risk management framework, by introducing some fundamental changes for individuals. After April the legislation will:
• Increase choice for individuals,
• Give responsibility for decision-making at retirement to individuals, and
• Shift risk to individuals.
In reality, the cost to, and opportunity for, the individual of increased choice in retirement is that the individual is now responsible for managing the ‘big four retirement risks’ – longevity, inflation, flexibility and volatility.