The 2015 pension freedoms have put the onus onto advisers to make changes in the way they approach retirement with clients. Although there are certain advantages from the changes, such as greater flexibility and new investment solutions, there are also added risks.
Major challenges to retirement investing include market risk, longevity risk, sequence of returns risk, and interest rate risk.
That said, when Quilter Investors invited a number of leading advisers to talk about the changing pension landscape on 24 October, many of the participants said they also worried about an often overlooked risk – inflation.
Until Brexit, at least, inflation was steadily falling in the UK, and even dipped below zero at times during 2015. So while bank rates were anchored near record lows, pensioners didn’t need to worry as much about losing the purchasing power of their money. Moreover, with the exception of brief spells in 2007-2009 and 2014, the UK consumer price index was below 2% for the most part.
Now these conditions are reversing. As the pound tumbled in the wake of the shock Brexit vote in June 2016, inflation picked up markedly; between early 2016 and early 2018, it rose from around 0.5% to 3% - far more than what banks were offering savers. And inflation remains a threat today, with the Bank of England reluctant to raise rates too soon as the country grapples with the ramifications from a potentially ugly Brexit divorce.
Shockingly, the FCA’s Retirement Outcomes Review recently revealed that 33% of non-advised customers in drawdown were only holding cash. Although advised investors are unlikely to hold cash alone, qualified IFAs still have to educate their clients – and look for alternatives to cash at a time when market risks are rising and cash-like alternatives are few and far between.
“When you retire you lose the best inflation hedge that you’ve ever had, which is your job, because wages tend to rise in line with inflation,” explained Anthony Gillham, head of investments at Quilter Investors. “So, if you’re taking your pension pot, which you’re no longer adding to, and you’re putting a portion of that into cash, well that’s a sure-fire way to lose money after inflation.”
Now more than ever, he said, clients and advisers should have important conversations, where IFAs can carefully explain how clients can balance inflation risk with market risks, and how to limit the latter in the event of a market tremor.
“As a fund manager, it’s about intelligently using cash - as a tool if you like - to help cushion some of the downside when we’re worried about markets,” he added. “And then actively redeploying that at other points when we think we can get some decent returns. I’m certainly thinking about that differently when I’m thinking about a retirement product, compared to when I’m considering an accumulation product.”
Another important element that was discussed in detail by participants was tax efficiency and the ability to broaden investment choices to boost eventual pension drawdowns.