Pension Freedom  

Getting the withdrawal profile right for clients in decumulation

  • Identify inappropriate and appropriate investments for decumulation.
  • Design and document a retirement centralised investment proposition.
  • Describe and document a client withdrawal profile.
Getting the withdrawal profile right for clients in decumulation

Most advisory firms have created centralised investment propositions (CIPs) as a way of matching the needs and objectives of different client segments to a range of investment solutions available.

However, CIPs created before pensions freedoms have necessarily focused on accumulation-type client objectives and investment solutions.

Following pension freedoms, advisers need to extend their CIP to explicitly consider the nature of advice in decumulation.

This article focuses on the key considerations when creating a CIP for decumulation, and the need to establish and monitor each client’s withdrawal profile.

Identifying inappropriate and appropriate investments for decumulation

First, we need to define terms. Decumulation means the running down of capital to provide an income.

In order to identify what investments are appropriate or inappropriate for decumulation strategies, we need to consider:

  • Dispersion of returns: the broader the dispersion of returns, the broader the range of outcomes, the greater the sequencing risk under a worst-case-scenario. Selecting an investment strategy with an appropriate dispersion of returns (as defined by asset allocation) is key. 
  • Durability: cash has the narrowest dispersion of returns, but is not durable – it will not last the course when regular withdrawals are applied over the expected time horizon. To ensure durability, a multi-asset approach should be considered over cash.
  • Value for money: given the importance of getting the right withdrawal rate from a portfolio, all-in fees come under greater focus. If sustaining a withdrawal rate of 4 per cent per annum is required from an investment strategy net of 2 per cent per annum fees, that is a greater challenge than sustaining the same withdrawal rate net of 1 per cent fees.

We would consider the following investment types to be appropriate: regulated investments that are transparent, diversified and liquid (e.g. collective investment schemes such as funds and exchange-traded funds). 

By contrast, we would consider the following investment types to be inappropriate: unregulated investments that are opaque, idiosyncratic and illiquid (e.g. Ucis funds); a portfolio of individual securities.

More specifically, we would consider the following multi-asset strategies appropriate for their given expected investment term: lower cost multi-asset funds (e.g. target risk funds, target date funds), and multi-asset ETF portfolios.

By contrast, we would consider the following investment types to be inappropriate: higher cost multi-manager funds; or single asset-class funds/ETFs (e.g. global equity).

Guidelines around the use of structured products and annuities also need to be incorporated.

Creating and documenting a retirement CIP

In order to create and document a retirement CIP, advisers should be mindful of 1) Financial Conduct Authority (FCA) guidance as regards centralised investment propositions; 2) FCA “PROD” on product governance following Mifid II; and 3) the FCA Retirement Outcomes Review.

While there is no fixed format for creating a CIP, advisers should consider creating a retirement CIP policy statement that outlines the systems, processes and controls in place for their CIP under the following suggested headings:

  • Governance
  • Client outcomes
  • Suitability and choice
  • Risk profile/withdrawal profile
  • Investment options
  • Communication
  • Training and education.

In accumulation, client suitability should be assessed by a risk profile, attitude to risk may be more relevant than capacity for loss, investment solutions focus on growing a pot, and sequencing risk is mitigated by regular contributions.

In decumulation, client suitability should be assessed by a withdrawal profile, capacity for loss may be more important than attitude to risk, investment solutions focus on making a pot last, and sequencing risk is compounded by regular withdrawals.

Creating a retirement CIP does not mean adopting a “one-size-fits-all” approach. Far from it. It means applying a high level of governance to the building blocks of a retirement solution, then incorporating them into an approach that is best for a client (and/or group of clients).

Most importantly, a retirement CIP should ensure that the investment strategy of a retirement portfolio is consistent with the withdrawal profile of each individual client.