Pension Freedom  

How to help clients choose the right income fund for retirement

  • Learn what impact the pension freedoms have had on retirement provision.
  • Consider how income funds can help clients to fund their retirement and the risks that these bring.
  • Understand how ratings can help advisers to find the best income funds for their clients.
How to help clients choose the right income fund for retirement

The pension freedom reforms, which relaxed the compulsion on retirees to purchase an annuity when accessing their pension pots, were announced by the government in 2014 and introduced a year later.

In parallel with this there has been a continuing shift in demographics towards an older population.

As a result, the demand for income funds has increased significantly, with the fund industry responding to this.

Advisers can help to make sure that the client has the most suitable income fund for their retirement needs.

As the name suggests, income funds pay out an income to the investor on a regular basis (e.g. monthly, quarterly or half yearly), with the amount depending on the mandate and performance of the fund.

To do this, income funds will invest in one or more of the following: equities paying dividends; bonds; property; and possibly other income-producing asset classes, either directly or through other funds.

More income funds now hold ‘alternative’ or ‘non-traditional’ assets, such as emerging market debt, high yield bonds and infrastructure in order to try and gain extra yield and diversification of income, although this can equate to greater risk.

Based on Defaqto's latest data for the UK market, the following numbers for the income fund sector are:

Type of income fundNumber of fundsAssets under management (AUM)Average Ongoing Charge (OCF)
Mainly equity244£159bn0.95%
Mainly bond692£755bn0.68%

Although multi-asset is the smallest of the three groups, it is currently experiencing by far the largest growth in assets under management (AUM).

Also, in line with the rest of the fund industry, charges across all these groups of income funds have been on a downward trend in recent years.

Return and risk

Investors in the decumulation phase will usually have the following requirements, but to different degrees in each individual case:

  • Minimise volatility.
  • Generate a regular and stable income, to cover everyday living.
  • Maintain flexibility e.g. for any large one-off payments.
  • Preserve capital, to provide an estate value.

For example, some people might want a high, and possibly growing, income but would accept the possibility of capital being reduced to zero before the end of their life, while others may require less of an income but would want to have more chance of leaving some capital to their family after their death.

Different income funds need to be used for these varying aims. 

Defaqto has developed a methodology for assessing the suitability of income funds for different client needs.

Most people are familiar with the risk rating of funds for the accumulation phase, where an independent firm will consider the overall volatility of a fund and/or similar measures, before placing the fund somewhere on its risk scale, typically one to 10, where one is the least risky and 10 is the most risky.

Defaqto has done the same for decumulation. As is the case with the accumulation investor, there is a questionnaire based on client requirements and attitude to risk for decumulation.

The results of this questionnaire put each client into one of four different suitability categories. Similar to Defaqto's accumulation ‘workflow’, there will be lists of funds ‘mapped’ to these different profiles that the adviser can then choose from for their client (see below).


Questions appear on the last page of this article.