How to manage income drawdown risks

Supported by
Scottish Widows
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Supported by
Scottish Widows
How to manage income drawdown risks
Source: Fotoware

So, what are the risks associated with drawdown and how should advisers best manage these?

Henry Tapper, executive chair at AgeWage, says: “There are two principal risks – firstly, drawing down too hard, with the risk of running out of money and secondly, not drawing enough to enjoy retirement while you can.” 

Tapper points out that as well as taking too much risk, too little can be an issue too: “Models suggest that there are risks from an overly conservative investment strategy. Advisers should therefore explain risk and reward through worked examples.”

Gavin Jobson-Wood, specialist business development manager at Scottish Widows, says: "A formalised retirement advice process ought to incorporate a thorough analysis of a client’s expenditure requirements in retirement, taking into account their capacity for loss. As a consequence, the most appropriate method of generating income may not always be flexi-access drawdown." 

He adds: “Liquidity can also be a risk on drawdown, especially where investments are in infrastructure, property and in unquoted stocks and bonds.” 

Financial planner Jon Young at WealthFlow takes a similar view: “The biggest risk with drawdown is running out of money. Everything else is secondary because when the pot is gone, it is gone and you are left reliant on state benefits, which are designed to cover only the most basic of outgoings.

“The best way for advisers to tackle this risk is through the use of a centralised retirement proposition. This should set out automatic changes to the investment strategy, such as de-risking or the benefit of holding more cash in comparison with the inflationary risk of doing so once a client starts drawing down on their pension. They should also check the sustainability of withdrawals. 

“With the old ‘4 per cent rule’ largely dead, consideration should move to using cash flow and stochastic modelling to gauge sustainability. Furthermore, advisers need to consider how much basic income should be covered through a guaranteed source for each individual client; it does not have to be drawdown or an annuity, it can take the form of drawdown and an annuity.”  

Catriona McCarron, wealth manager at Ascot Wealth Management, reflects on the wide range of drawdown risks, as she explains: “Drawdown comes with multiple risks, such as investment risk, longevity risk and the less obvious risk of having flexible access – the ability to dip into the pension pot as you would dip into an Isa, for example. 

“The risk here is getting complacent and withdrawing capital that could impact on the affordability of designated income drawdown in the future. Advisers should use appropriate suitability letters and risk warnings when addressing drawdown objectives with a client, so that they understand this risk.

“Advisers should also manage client expectations and advise on realistic and sustainable drawdown figures. In addition, they should use cash flow modelling to provide insights into the client’s capacity for loss, the pot’s reaction to a financial crash, or for how long the client’s existing level of income is affordable. 

More drawdown risks

Jonathan Cooper, head of paraplanning at Drewberry, also points to a wide range of drawdown risks, as he says: “Along with the usual risks associated with any investment, such as systemic, non-systemic, diversification, counterparty, interest rate and inflation risks, there are others to factor in, such as sequencing, legislative, political and tax risks. Clients should not enter into a drawdown arrangement lightly and should be aware of these risks. 

“Drawdown is a balancing act between risks, desired investment returns and flexibility. Ongoing monitoring and professional advice to provide a dispassionate view on whether a drawdown route remains suitable and whether alterations to strategy should be made is essential, even mandatory.”  

Ryan Medlock, senior investment development and technical manager at Royal London says: “Drawdown is and always has been a risky product. The Financial Conduct Authority has continued to stress its concerns about the suitability of drawdown advice and this remains one of its key priorities. 

“In recent years, drawdown has increasingly become the default retirement recommendation, partly due to its flexibility around both income payments and inheritance benefits, but also as a consequence of annuity rates previously hitting all-time lows. 

“There’s no doubt that staying invested during a rising market can deliver some short-term benefits for drawdown clients, but I dare say the market conditions we’ve experienced over the past 18 months won’t be what many clients would have originally signed up for and indeed hoped for. 

“This, therefore, may be a good time for advisers to review and potentially re-set their drawdown advice processes. That doesn’t just mean where drawdown clients are invested, it means their whole framework for providing retirement planning advice. This includes re-evaluating their processes for fact-finding, assessing their retirement clients’ risk appetite and capacity for loss as well as managing sequencing risk, income withdrawal rates, longevity and, of course, income sustainability."

Medlock adds: “Some drawdown clients in higher-risk investments may never have felt the full magnitude of this level of market volatility before and may not have the capacity or inclination to tolerate movements of this kind again. 

“For some, significant reductions in investment sustainability scores may bring about a need to re-evaluate risk appetite and capacity for loss, and this is where risk-profiling and income modelling tools can support client conversations. An effective and robust framework will mean advisers are better able to respond to market conditions and adjust income levels in order to enhance their clients’ long-term retirement income plans and help preserve their value.”   

Jobson-Wood says: "If an investment solution (drawdown) is considered appropriate, then sufficient investment risk ought to be taken by the client that’s consistent with their [attitude to risk], but also to ensure there’s the opportunity for real (above inflation) levels of growth and, therefore, helping to maintain the purchasing power of income withdrawals.

"In addition, advisers ought to determine the appropriate levels of withdrawal – both to meet the client’s expenditure requirements but also to help ensure income sustainability through retirement.

A comprehensive and regular review process, incorporating an adjustment to the level of income withdrawal where appropriate, ought also to be an essential element of an adviser’s retirement advice proposition." 

Fiona Nicolson is a freelance journalist