Before pension freedoms, retirement options were black or white. The advice was either to purchase an annuity or invest in drawdown. Now we have pension freedoms it is no longer such a binary choice and good retirement planning should involve a combination of options.
I have been advising clients and writing about retirement options long enough to be realistic about the opportunities for fine-tuning retirement advice from a single-product solution to a multi-solution approach. It is much easier to talk about, than recommend, more than one solution. So, this begs the question: what is the best way to advise a client throughout their retirement journey?
I think the key to unlocking the multi-solution approach is to recognise the various twists and turns the retirement journey takes. Although every client will be unique, there are enough similarities to map out a typical customer’s path into later life.
There are four stages to the typical journey; before retirement, at retirement, during retirement and later retirement. At each stage there are technical and behavioural issues to consider. Most advisers are good with either technical or behavioural aspects, but few are good at both. This means advisers who want to provide the best advice need to brush up on both areas.
I will look at each of these stages and suggest solutions that may be appropriate depending on circumstances. Before we look at these stages it is worth reminding ourselves that it is often difficult to define a retirement date because more and more people are adopting a fluid transition from full-time work to full-time retirement over several years.
Take someone who decides to take their tax-free cash at age 60, but not take income until 65 because they are working part-time or on projects. There is a five-year gap when they are partially retired. Good advice will take this transition period into account. In my experience, this period of partial retirement can stretch for 10 years or more, which is further evidence that the old black-and-white model is outdated.
Before retirement
In the countdown to retirement, emphasis is on the investment strategy, which might mean finding the right glide path. There are some product solutions ideally placed to help manage the de-risking process. In some situations, unit-linked guarantees might have a role to play.
If tax-free cash is taken but no income, there could be a role for fixed-term income plans if investment risk needs to be eliminated.
At retirement
This is point where the full range of retirement income options come into play. Post pension freedoms, the trend seems to be towards drawdown in early retirement, but other solutions should not be ignored. The choice of product solutions should take account of not only client objectives, but also a view about the future trends in financial markets.
Generally speaking, at the point of retirement, many clients favour the flexibility of drawdown over the guarantee of an annuity. There is no doubt that the generous pension death benefits and advantageous tax treatment before the age of 75 swing the balance in favour of keeping pension pots in a flexible wrapper.
But advisers should not discount the advantages of a combination of annuities and drawdown. It may not be as simple as having some money in annuities and some in drawdown to hedge the bets, because the combination should reflect client circumstances and the financial outlook. So the combination can be fine-tuned. There is still a strong case for fixed income plans for those who want guaranteed income and flexibility at the same time. Fixed term income is also helpful if there is a need to bridge an income gap, for example until the state pension kicks in.
During retirement
As every adviser knows, drawdown is an investment solution that needs regular reviews. Once-a-year reviews are common, but it makes sense to keep a watching brief to identify early signs of pending trouble. If advisers think there may be trouble ahead with Brexit they should take this into account when recommending investment strategies for drawdown. For instance, the potential market volatility resulting from Brexit will bring the issue of sequence of returns into focus.
Annuities start to come into their own at older ages and there is a strong case for locking into annuities when the benefit from mortality cross subsidy becomes significant. There is no age for this, but if there is an optimum time to purchase annuities it is closer to 70 than 60.
The chart shows the relationship between annuities, gilt yields and the FTSE and shows the importance of keeping an eye on annuities and investment returns.
The more sophisticated adviser will be looking to identify times when the pension fund has grown and annuities look attractive. This shows the value of a thorough review process.
Later retirement
In later retirement, the investment strategy should err on the side of caution with less risk being taken and, as previously mentioned, the case for annuities becomes much stronger.
Equity release is a product solution that may be considered in later life if additional income is needed. This solution should be viewed like the Bank of England; as a lender of last resort.
Retirement as a journey, not an event, is more than a convenient sound bite. It reflects the true nature of retirement and good advisers will adapt their advice processes to reflect the new dynamics of retirement, which lends itself to a multi-solution approach.
Billy Burrows is a director of Better Retirement Group
Key points
In the countdown to retirement, the emphasis is on the investment strategy.
At retirement, many clients favour the flexibility of drawdown over the guarantee of an annuity.
Annuities start to come into their own at older ages.
