The transition from accumulating retirement funds to drawing an income used to be relatively problem-free for advisers: annuity rates were healthy and income drawdown withdrawals were restricted by Government Actuary Department rates. This meant that consumer overspending in retirement, using money wrapped in pension arrangements, was extremely unlikely.
But in the past decade the pension freedoms and other factors have heralded a dramatic shift in the way consumers access their retirement pots, and greater flexibility has made things tougher from the planning perspective. This was underlined by comments made last month by the FCA in its annual sector views paper.
The regulator said: “Some adviser firms have not yet updated their investment strategies for decumulation clients. In addition, they may not have adequately considered decumulation risks.”
What these strategies should look like is a matter of debate. Some advisers are taking fresh approaches, but they also feel there is no need to reinvent the wheel.
Paul Gibson, managing director at Granite Financial Planning, says: “Our investment approach does not necessarily change when clients start drawing an income from portfolios, but our planning approach does. Sustainability of income and portfolio longevity are front of mind, and we discuss tactics and strategies to try and ensure the retirement pot outlives the client.”
Watch out for ravaging
So what are the risks to which the regulator was referring? Although a client’s appetite for volatility may remain the same upon reaching retirement, their objectives switch from growth to income. The Lang Cat’s Mark Polson says that many firms are merely adjusting accumulation strategies into income-optimised products. And the consultancy’s research indicates, 70 per cent of companies are maintaining their clients’ existing portfolios and withdrawing cash.
But withdrawing funds at the wrong time can have a lasting effect on the remaining pot. A report by Thesis Asset Management outlines six key pitfalls for retirement income clients:
- Significant market falls;
- Volatility drag;
- Sequencing risk;
- Pound cost ravaging;
- Inflation risk;
- Longevity risk.
All should strike a chord with intermediaries, if not consumers. Generally, consumers will be aware that living longer and high inflation will make drawing a sustainable income more difficult, but sequencing risk and pound cost ravaging may draw blank faces.
The latter is simply the opposite of its better-known counterpart, pound cost averaging. Instead of investing regularly in volatile markets with a view to purchasing some shares at a lower price, pound cost ravaging requires the selling of more shares when markets are low in order to generate the required level of income. When this income dwindles away, and the individual has no access to other, less-volatile assets, then they are left with few answers other than perhaps turning to equity release.
A further issue for intermediaries concerns the platforms on which they manage investments. As Mr Polson adds, many still offer extremely limited functionality, and prevent advisers from working across several client pots at once – a possible barrier to the implementation of “hybrid” retirement income strategies. He believes technology will soon help resolve this problem, but for now platforms often struggle even with relatively straightforward tasks such as drawdown illustrations.
But while the industry can agree that all these issues present risks, opinion is split on whether products need to change alongside adviser and platform practices.
The FCA appears to think so: its sector views paper flagged identifying appropriate retirement income products as another area of concern with respect to advised sales.
“A lack of innovation in retirement income products, product complexity and fee structure opacity, together with the complex nature of the financial needs these products aim to meet, make this a challenging area for both consumers and financial advisers,” the regulator said.
“The presence of a few large providers that control the majority of assets held in pension savings products limits the incentive for competition in this space.”
Lawrence Cook, director at Thesis Asset Management, says although there isn’t a shortage of literature, it is true that few solutions are available on the market.
“I have attended many conferences in the past year where advisers have asked for evidence of new and innovative solutions, but often they have been left disappointed,” he says.
“Not all advisers feel this way yet, but I suspect this will change as understanding of accumulation and decumulation improves.”
Investors should have a more defined strategy than just investing in a handful of multi-asset funds, Mr Cook adds. He says to do otherwise is problematic, as the client is at the behest of the fund manager selling across all assets in order to produce the income.
“Clients, over time, should be rotated out of less-risky assets, such as cash and cash-like assets and into equities, which will provide a portfolio with long-term sustainability,” he argues.
“It is important to use cash and bonds first and leave equities untouched – this will ride out any volatility over the short term and mitigate the risk of pound cost ravaging. A fund simply cannot do this, and using a traditional multi-asset model portfolio service where all assets are sold down proportionately each time for a withdrawal suffers the same problems.”
Intermediaries, however, still see multi-asset as a key cog in the wheel. Cicero’s ‘Retirement income experience study’, published in March 2018, found 96 per cent of advisers expect multi-asset funds to form at least a portion of a client’s portfolio.
Bring on volatility
Perhaps the biggest concern for retirees using equities to draw income is a downturn in markets.
Anthony Gillham, head of investment at Quilter Investors, says: “From a market perspective, apart from a couple of wobbles, things have been pretty benign since pension freedoms. It hasn’t been so apparent that a different solution has been needed for decumulation; the rising tide has lifted all boats.”
But markets have taken a turn over the past six months. The FTSE 100 index, having edged towards the 8,000 point mark in May 2018, had dropped to below 6,600 points by the end of December. It has since recovered fractionally, but the depth of fall would certainly have impacted those using equities for retirement income.
With both political and economic concerns mounting – such as the continued uncertainty over the fate of the UK’s Brexit deal – there are fears markets could be set for a tough time this year, too.
However, sharp market movements can have their advantages, according to some. “If anything, volatility should be embraced,” says Mr Cook.
“By rebalancing on a regular basis from less-risky assets – such as bonds and cash – to equities, which as we have seen in recent months have undergone a significant devaluation, clients have the opportunity to buy at depressed values. This will allow them to experience the long-term gains associated with equities and give them a greater chance of not running out of money during retirement.”
Whether volatility is a feature or not, the task of keeping pace with inflation while continuing to draw an income will always need to be addressed. Mr Gillham believes particular types of asset are required to meet this aim, such as infrastructure equities and bonds.
He says: “It’s attractive because the underlying asset typically has some direct economic linkage with inflation. The best example is the cash flows that a railway might generate: they tend to rise with inflation because the fares are regulated, and governments will only permit those fares to rise year after year in line with inflation.”
Annuities had previously been a staple of income for consumers reaching retirement with defined contribution arrangements. But increasing longevity and interest rate cuts to counter the 2008 financial crisis caused rates to plummet. Pension freedoms then added salt into the wounds of annuity providers.
This has meant that while annuity popularity has slumped, drawdown sales have soared. However, a complication with this shift has been that annuities and drawdown, despite essentially aiming for the same objective, have contrasting sets of risks.
Those that have sought advice are better positioned to understand and navigate these issues. But FCA data published in September last year found just under a third of both drawdown (31 per cent) and annuity (28 per cent) sales are conducted without advice, meaning consumers are running a greater risk of frittering away the pot earlier than needed when it comes to the former.
There are challenges for intermediaries, too, and there is little doubt that a new era of planning has begun.
Verona Kenny, head of intermediary at 7IM, says: “In many cases, advisers are now finding themselves in unchartered waters. Previously, many advisers would advise their clients to buy an annuity for certainty of income, but with the advent of pension freedoms, advisers now have an increasing segment of clients where decumulation strategies make more sense.”
This is supported by the Cicero report, which found that in 2015 advisers were typically starting conversations about retirement income when clients were aged around 50. But in just three years this age has dropped by almost a decade.
Dhawal Chandan, chartered financial planner at Just Financial Group, says: “The education piece is one of the most important aspects. We start educating our clients from the accumulation phase onwards. From that we get a gauge in terms of the client’s income requirements, and then work out cash flows and financial plans on that to give them a realistic idea of what they’re aiming to have.”
From a client perspective, Cicero also identified an increase in the demand for flexibility over the past three years (from 73 per cent to 79 per cent). That was to be expected, but other results did show a degree of conflict between client and adviser priorities.
Whereas clients now feel less eager to remain invested during their retirement, and more positive on annuities – ‘anti-annuity feeling’ fell from 51 per cent to 36 per cent – the latter is not the case for intermediaries. The proportion of advisers who said conventional annuities represented terrible value no matter what the pot size rose from 22 per cent over the period.
Despite that, blended approaches to retirement income are still common among the advisory community, as Table 1 shows.
Table 1: Blended approaches to retirement income
Likelihood of adviser considering approach (on a scale of 1-7)
Annuity for basic spending, remainder in drawdown
Move all assets from annuity to drawdown when the time is right
Gradually phase from annuity to drawdown
Drawdown plus product paying lump sum if client lives beyond a certain age
Source: Cicero. Copyright: Money Management
Ms Kenny also thinks that a combination of annuities, alternative investments, centralised investment processes, plus ongoing service is the right approach.
“Service is going to be increasingly important, because you need to consider sequencing risk to help clients avoid drawing down from their pots when markets are low, for example,” she says.
“Asset allocation also needs to remain flexible if retiree clients are still invested in markets to make sure it is appropriate across all their tax wrappers, so that ongoing management will be key as this area grows.”
It remains to be seen whether this will filter through to sales figures. The latest data from the FCA, released in September 2018, showed annuity sales in the six months to last March were around a third of drawdown sales and less than a quarter of full cash withdrawals.
One area on which most advisers can agree is the need for centralised retirement processes. For the accumulation phase, centralised investment processes have been gaining traction in the past few years, but the retirement phase is still underdeveloped.
When surveyed by Cicero, 72 per cent of intermediaries either agreed or strongly agreed there was a need for a more robust and centralised retirement income planning process, and only 3 per cent disagreed, with no one disagreeing strongly (see Chart 1). Perhaps the greatest concern is the lack of change from just three years ago, when 71 per cent of advisers said the same thing.
Chart 1: Adviser responses when asked ‘how far would you agree that there is a need for more robust and centralised retirement income planning processes?’ (%)
Mr Cook adds there are still too many advisers manually managing clients’ decumulation strategies, which could mean consumers end up in a one-size-fits-all type solution. He does concede, however: “Many advisers are getting it right with the pots approach, they just need more choice when it comes to providing this service.”