Securing retirement income in a low-interest rate environment is becoming increasingly challenging for financial advisers. Falling gilt yields post-Brexit saw 10-year UK government bonds drop to a historic low of 0.50 per cent in August. And the prospect of rates rising sharply anytime soon appear remote.
So as annuity rates plunge, drawdown is likely to continue to emerge as the more popular option.
For those planning for retirement income, where we need to focus is not just on attitude to risk but on a customer's capacity for loss – two very distinct but interrelated concepts that need to be understood fully on a client-by-client basis before any decision is made around the best option for delivering that retirement income.
The FCA has described capacity for loss as “the customer’s ability to absorb falls in the value of their investment. If any loss of capital would have a materially detrimental effect on their standard of living, this should be taken into account in assessing the risk that they are able to take.”
It is really only when the customer’s capacity for loss is established that we move to understanding their attitude to risk. And by that we mean understanding the level of risk that a customer is comfortable with in pursuing their income objective.
Capacity for income loss and attitude to risk are more relevant in the current economic climate where falling interest rates and prolonged market volatility may lead to a recalibration of client expectations in relation to their retirement income. So advisers are not changing the way they plan but changing the conversation with their clients around their longer-term income prospects in retirement.
Moving into the more risk-laden assets has ramifications for retirement income.
Recent research conducted with eValue shows the implications for pensioners of investing in various risk-rated portfolios and what a sustainable level of retirement income is that has a “reasonable” chance of success.
The full research is set to be published in October but we have a preview of some of the early findings.
For the analysis below, the researchers have taken 95 per cent as a typical level of chance of success (a 1-in 20-failure rate). They have used quite conservative failure rates here, given advisers may have a pool of customers who are affected by an economic event such as a market fall – what we loosely refer to as concentration risk.
If we take eValue’s investment profile with a risk rating of 4 (see chart for composition), their economic stochastic model projects that a pensioner can take an income of 3.3 per cent for 30 years with a reasonable chance of not running out of money. Invest in a risk profile of 7 and this number goes to just over 2.8 per cent.
Here’s an example to illustrate this:
Joan retires at age 65. She opts to invest in drawdown in a portfolio that corresponds to eValue’s risk profile 4.