The idea of arranging a combination of retirement income policies to create a blended solution instead of a single annuity or drawdown policy is not new but the new pension freedoms have thrust this concept firmly into the limelight.
Now there are more options to consider and increased flexibility is more readily available, the case for a blended solution is stronger than ever.
Here I will use the term ‘blended solutions’ or ‘blending’ to refer to the concept of arranging a combination of annuity and drawdown options (including investment-linked annuities and fixed-term annuities) instead of a single solution.
In many cases, a blended solution of retirement income options produces a better outcome than a single product solution. This begs the question ‘what is a better outcome?’ The rest of this article will attempt to answer this question.
Why consider a combination of retirement options?
By far the most important reason to consider a blended solution is that it may result in better outcomes for clients reflecting the changing face of retirement.
There are many factors to take into consideration, such as:
Thinking about future life expectancy
Setting out retirement objectives
Understanding how much risk should be taken
Working out how to reduce the amount of tax clients will be paid.
In practical terms this means it is more important than ever to separate the strategy from the tactics. The strategy is about setting out a plan for the future and the tactics is about deciding which financial policies best fit in with the plan.
It is also important to remember that a blended solution is also more likely to meet the regulatory requirement that all relevant options are considered. One of the highest priorities for all compliance departments is to have documentary evidence that every client has been taken though a structured decision-making process and to be satisfied that the advice recommendation is suitable and takes account of individual circumstances.
There are a number of ways of justifying the case for a blended solution but the strongest cases can be made on the following basis:
It reduces or diversifies risk in retirement
It enables clients to meet more than one retirement objective
It produces better client outcomes.
Reducing or diversifying risk in retirement
A good case for blending can be made by looking at the risks facing people at retirement and looking for ways to reduce these risks. Generally speaking, people are not faced with binary risks, such as income or capital risks, but a multitude of risks including:
Risk that inflation will reduce spending power
Risk of living longer than expected and running out of income in the future
Risk that circumstances such as health or income requirements may change in the future
Risk that equity prices and or interest rates could rise or fall.
There is no single policy that effectively manages all of these risks. For instance a guaranteed annuity is the only way to protect against the risk of a client outliving their pensions but it does not provide flexibility if circumstances change. Drawdown is the most flexible option but there is a risk that fund values could fall if future investment returns are less than expected and there is a risk that income could eventually run out.