Personal Pension  

Blend into retirement

This article is part of
Combine harvest

Life was a degree more simple before pension freedoms – if clients had modest pension pots they were generally offered a lifetime annuity. This provided a guaranteed income for life. From an advisory position, knowing from the outset how long the process would take, and charging a fee that was in line with client expectations, it was straightforward.

However, for many clients, annuities may have felt like a straitjacket solution – no flexibility whatsoever. With annuity rates under considerable pressure after the financial crisis, the inevitable questions emerged as to whether they were providing value for money. Could pensioners be better served by allowing choice over how they took their savings? And so pension freedoms were born.

Does that now mean the abandonment of annuities – do they still have a place in the advice process?

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The answer is no, and a definite yes. The need to meet a range of different client objectives, particularly for clients who would have previously purchased an annuity, is reason enough. Abandoning the security that annuities offer would be foolhardy and unnecessary. Adopting a blended strategy could be the answer – a good compromise with striking a balance between risk and reward, security and flexibility.

A blended strategy is simply the process of using more than one retirement product/wrapper to provide a solution, usually by mixing guarantees with non-guaranteed investments. It can be the most straightforward way to meet pensioner objectives. I use the term ‘pensioner’ in the loosest of terms, as we should recognise that many individuals may take retirement benefits without actually retiring.

Changes to the pension landscape have been gradually evolving over the past decade, partly as a result of final salary schemes closing and a stubborn financial climate of low interest rates. These factors have impacted savers significantly – in pension arrangements and for those retiring. Advisers are used to adapting to new financial legislation, but these pension reforms have brought new challenges.

The introduction of pension freedoms has, for many advisers, resulted in a change to the default position of recommending an annuity to that of investing in a flexi-access drawdown arrangement. In the past, income withdrawn from a drawdown arrangement was restricted to a level set by the Government Actuaries Department (GAD) primarily to avoid running out of funds. This restriction has been removed.

The shift away from annuities to drawdown exposes the client to a new risk of running out of income. It is not simply the uncontrolled level of income that a client can withdraw, but also how their investments perform. Without professional advice, this risk increases significantly for a pensioner.

Given these new risks, it is understandable why advisers often find themselves caught between a rock and a hard place when it comes to giving advice for clients who have modest pension pots. Because the process involves advising on all the new options, there may be underestimation of what is an appropriate charge.

There is no magic bullet to achieving both total security and total flexibility for the client. Guarantees will generally mean some degree of restriction and flexibility, meaning accepting some degree of risk. When asked to prioritise objectives, many clients say, a guaranteed income is top of their list, followed closely by the ability to alter requirements if circumstances change. It is no great revelation that typically, but not exclusively, those with larger pension pots (the higher net-worth) worry less about security and focus more on flexibility.