Advisers fail to evidence suitability of drawdown

Advisers fail to evidence suitability of drawdown

Advisers need to better explain to clients - and provide proof of - the suitability of a recommended drawdown plan to ensure they understand the implications of their decisions, a new report has warned.

The paper, produced by Defaqto with backing from provider Prudential, warned one of the main issues with drawdown was evidencing.

Up to one in five advisers are failing to use cashflow planning to determine the sustainability of a client's income, it found.

Cashflow planning is not a regulatory requirement but can help justify an adviser's recommendation.

One way to evidence whether the level of income being taken is suitable and sustainable is to, at least annually, take the capital balance of the remaining savings and the income being taken and test it against a benchmark such as critical yield, natural yield, Government Actuary's Department rates or an annuity rate, Defaqto stated.

While using Gad rates as a benchmark is no longer a regulatory requirement, Defaqto said it was good practice to evidence ongoing suitability and doing so could enhance the client's experience.

Richard Hulbert, insight analyst for wealth at Defaqto, said the problem with proving only the sustainability of income for the client, but not of the capital, was that sequence of return and other risks could be overlooked.

He said: "What [some advisers] do is they take a rate of 4 per cent [drawdown] but do not evidence that the fund is capable of providing 4 per cent [in the long run].

"If a client says to you [a certain] rate is what they want that is not an appropriate income level going forward. You need to be able to evidence why you are using that figure.

"I can not see how people would be able to justify not evidencing the rate they have chosen."

The research firm pointed to modelling tools as a way to illustrate the recommended solution projected over the client's lifetime.

But it cautioned to be sensible with the assumptions used in the illustration, such as economic circumstances, taxation, investment returns and income yields. 

FTAdviser reported in March that stochastic cashflow modeling appeared to be the more popular choice for determining whether a client will run out of money in retirement, despite not being used by widely available adviser software.

Stochastic modelling, as opposed to its deterministic counterpart, uses lots of historical data to illustrate the likelihood that something will happen, such as the client running out of money. 

This means the tools, which are considered the more scientific of the two, will not produce a specific number but a range of possible outcomes. 

Deterministic tools arrive at a specific conclusion based on the values put in by the adviser.

The Financial Conduct Authority's stance on using the tools was outlined in its recent policy statement on advising on pension transfers.

The FCA stated: "Firms are not prevented from using cashflow modelling software or any other type of software.