Posted by: Intelligent Pensions | January 16, 2012

IFAs should review drawdown annually to avoid FSA clampdown

Article: IFAs should review drawdown annually to avoid FSA clampdown | Publication: FT Adviser | Date: 16 January 2012 | Author: Donia O’Loughlin | Quoted: Andrew Pennie

Retirement specialist warns FSA wants to see “evidence of continued suitability” to take account of changes in clients’ circumstances.

IFAs are putting their business “at risk” if they do not carry out annual retirement reviews as the Financial Services Authority will be scrutinising this area post-Retail Distribution Review, pensions consultancy Intelligent Pensions has claimed.

Andrew Pennie, marketing director at the firm, said that the FSA’s reviews into product suitability reflected a shift on the part of the regulator to focusing on the ongoing suitability of products to client needs.

Mr Pennie told FTAdviser that products such as drawdown, which currently have to be reviewed on a three-yearly basis as a minimum requirement according to HM Revenue & Custom rules, could come more under the regulator’s spotlight.

He said: “IFAs are under increasing pressure to be able to prove to the FSA’s satisfaction that their ongoing drawdown advice to existing clients is fit for purpose.”

Mr Pennie said that overall drawdown assets are now estimated to be worth around £20bn and growing, with the regulator keen to ensure they are being managed correctly and clients given suitable advice over time.

According to Mr Pennie, the FSA wants to see “evidence of continued suitability” as clients’ circumstances change the advice must also change.

He said: “Advisers realise that regulatory action is a clear risk unless they can show robust drawdown review processes.”

Therefore, while Mr Pennie said that IFAs only need to review drawdown every three years, he believes there is a “strong case” for this to be reviewed annually.

He said: “Carrying out reviews at least annually is essential to avoid any risk of what was originally a suitable arrangement falling into unsuitability due to changes in a client’s needs, priorities or circumstances.”

However, he emphasised that IFAs need to ask the right questions. He pointed out that reviews need to focus on the client’s circumstances, including any change in their health and not just the investment performance.

Mr Pennie said: “Illness can strike in a short space of time and transform a retiree’s financial requirements. That means reviews need to incorporate a detailed health investigation.”

Contact Andrew to discuss any of his comments from this article

Posted by: Intelligent Pensions | December 14, 2011

Grabbing a flexible lifeline

Article: Grabbing a flexible lifeline| Publication: IFA Online | Date: 14 December 2011 | Author: Fiona Murphy | Quoted: Steve Patterson

Six months on from reforms and in a sustained period of market volatility, Fiona Murphy looks at how advisers should tackle the issues that income drawdown presents

Six months is a long time,” sang The Smiths. Perhaps they were right: we are now six months into the new income drawdown regime. While the changes have been well received, advising in this area has not been an easy task because of unique market conditions.

The first issue is the government’s decision to cut the GAD limit from 120% to 100%, aiming to prevent people drawing down their pots too quickly and falling back on the state. The change has polarised the industry, with some industry figures lobbying the Treasury, saying it could not have come at a worse time. Clients coming up for drawdown reviews face a witch’s brew of issues hitting drawdown pots. Choppy investment markets have put a dent in many people’s pension pots. This, coupled with the decreased GAD limit means many retirees are facing a sizeable decrease in the income they can take from their pots.

However, there are others who say the higher GAD limit was unsustainable, particularly as people are living longer. However, no matter what side of the fence you are on, it is clear to see the change is having a negative impact on many people’s income.

A case study from AJ Bell explains how an average investor could see their retirement fund decrease. A 60-year-old man with a fund of £300,000, who went into drawdown on 1st December 2006, had a maximum annual income of £22,320. AJ Bell forecast that his annual income would grow to £25,200 on his review date in five years’ time, rising as he aged. But now the review has arrived, he will have only a maximum annual income of £15,432, a huge drop of over £9,000. This could be grossly out of step with his retirement aspirations and financial obligations.

But how did this shortfall happen? AJ Bell calculated the pot was struck by: falling gilt yields (38.24%); the 20% uplift removal (37.19%); plummeting investment markets (18.18%); and the Government’s GAD table update (6.38%).

Clients with a strong IFA relationship should be well aware that drawdown is an investment product that will go up and down to mirror the market. They should have been profiled to assess whether it would suit them best, as opposed to the guarantees of the annuity path. For AJ Bell’s marketing director Billy Mackay, the key challenge for advisers is: “People have to understand the nature of the risks they are exposing themselves to.”

But, with many becoming risk-averse following significant losses to their savings, advisers should be monitoring portfolios to establish whether clients are gaining the outcomes they hoped for and whether remaining in income drawdown continues to suit their risk profile.

Intelligent Pensions’ managing director Steve Patterson says: “A well-organised adviser will have the position by and large under control with a process that should lead to a successful outcome in all cases.” These successful outcomes should include helping clients wanting to come out of drawdown during a period of volatility.

In that case, how often should advisers see their drawdown clients? While it is compulsory for people to review their drawdown portfolio every three years, there are no guidelines for frequency of client contact. Many advisers advocate the benefits of regular reviews to ensure the client’s portfolio is in tune with their changing needs. For AXA’s head of pension development Mike Morrison, the need to see an IFA has increased, he hopes: “At least once a year, in volatile markets.”

Scrutinising drawdown

But the IFA meeting can have other pitfalls, as the FSA has placed increasing scrutiny on drawdown advice. As Morrison says, the FSA “couldn’t comment on whether the advice was good or bad, because people’s records weren’t good enough”. Advisers have to ensure they document the advice process adequately. However, while the FSA is scrutinising drawdown advice at point of sale, there is also another issue that older clients could be “drifting into unsuitability” for drawdown following the removal of the Age 75 rule.

Quite simply, a number of people could remain in drawdown throughout their seventies, although other options could be more suitable. For instance, as the client ages, an enhanced annuity could become more appropriate due to the guarantees and the mortality cross subsidy granting a higher rate of income. Patterson explains that previously there was “a regulatory event horizon, because advice had to be given, to go into ASP or convert to an annuity”.

However, now there are no guidelines on how clients should fund their latter years. With this in mind, advisers should be monitoring older clients more closely and planning exit strategies accordingly. Mackay says: “At some point, people should be thinking about buying an annuity. Many clients in drawdown appreciate having an annuity available as an option. They like the control of funds they have actively invested and taking funds from it. However, while it’s an option, I don’t think it’s a given, going down the annuity route.”

However, annuities are not without their problems, as rates have continued to fall. Ultimately, advisers have to decide whether this route is best for their client: annuity purchase is a question of timing. When looking at alternative options to increase income, the adviser should review the drawdown contract carefully. The AJ Bell case study highlights a pressing problem. As the member’s annual review will not happen for another three years they could find themselves locked into a low GAD rate (December’s GAD rate was historically low at 2.5%). A potential route is a provider switch.

Morrison says: “Some providers offer a member nominated annual review, so you can re-calculate your income each year. One thing [for clients] to talk to [their] adviser about is whether it is worth moving the contract to one of those providers who offer a member nominated annual review.” If next year, gilt yields have gone up and investment markets have stabilised, that client could carry out the review and fix a higher level of income.

While members of capped drawdown have found themselves hamstrung by the reduction in GAD from 120% to 100%, the new rules also brought in flexible drawdown, which enables individuals to draw unlimited funds, subject to meeting a minimum income requirement. So, are advisers seeing more clients turn to flexible drawdown at a time where gaining access to more funds could be a lifeline, not a privilege?

According to IFAs, this is not the case. Although there was keen interest when the changes were unveiled, it has not manifested into a desirable take-up. The Retirement Adviser’s divisional director Nick Flynn says his clients “have put themselves in the situation where they can flip the switch [between capped and flexible drawdown] whenever they want and draw as much income as they see fit. But none of them are doing it. Everyone wants to take advantage of it, but no one’s ready to take advantage of it.”

While people want to make sure they can enter into flexible drawdown if and when they need it, (for example, to help children onto the property ladder), they do not want to raid their funds while the value is depressed. Hornbuckle Mitchell’s sales and marketing director Mary Stewart has seen many in the “planning phase” as they are making the most of carry forward rules for next year.

However, she believes that flexible drawdown could take off in a meaningful way as baby boomers retire as many will have amassed sizeable final salary pensions. Also a market recovery could mean current cautious investors could decide to make the leap into flexible drawdown.

Alongside the potential financial rewards of good market timing or a product switch, advisers should review providers in the light of a recent warning from Hargreaves Lansdown. Some providers have not updated their systems in line with the new rules, automatically forcing people to annuitise at 75.

Pension investment manager Laith Khalaf also cautioned: “It’s important for each individual to look at the service, cost and functionality of their plan” to assess whether it is fit for purpose in light of the legislative and market changes. Advisers should ensure their clients are not hit by these hidden risks and put steps in place to ensure they can transfer provider in a cost-effective method.

A diverse porfolio

But, what else should be in place to mitigate huge losses to retirement incomes? For some advisers, a pension alone is simply not enough. Advisers should ensure clients have a diverse portfolio to secure the best outcomes in retirement. Morrison says: “If a client has savings and other investments it might be possible to take income from them and build into their overall income requirements.”

While the changes to the drawdown regime have given much extra flexibility to clients it is clear this levels extra responsibility on advisers. However, by keeping a close eye on the investment markets and taking well-timed decisions on income levels and risk tolerance advisers can really help their clients to weather the current conditions.

Contact Steve to discuss any of his comments from this article

Posted by: Intelligent Pensions | November 15, 2011

Why phased annuitisation should be an option

Article: Why phased annuitisation should be an option | Publication: IFA Online | Date: 15 December 2011 | Author: Steve Patterson

Steve Patterson looks at how the annuitisation process can be managed for drawdown clients

Most advisers tend to think of pension drawdown as a product. But in reality, it is not. Legislation permits anyone in a regulated pension scheme to draw down their benefits as an alternative to buying an annuity.

Of course, many schemes and policies do not have the facility to accommodate drawdown and so usually, it is necessary to transfer to a plan that does. But there is no such thing as a drawdown policy per se.

The reason I highlight this is that it affects the advice process and the approach to the issue of annuitisation. It is not whether to annuitise that is the key point, but when.

For the majority of retirees on low to middle incomes, they may not be able to afford any risk to their retirement income.

But in all other cases, it is likely to be better to delay annuitisation until later in retirement, as the cost/benefit balance is far more favourable due to the higher level of mortality cross subsidy available at older ages. So, when is the right time to annuitise? 

That will vary from case to case, but the period from 70 to 80 years is likely to be the most favourable. In addition, it is a mistake to think there is any one point in time that buying an annuity becomes suitable. This is a “shades of grey” ­issue instead of a black and white one.

Phased process

A phased annuitisation is likely to be far more appropriate, ­taking ­advantage of market conditions, which may be more to do with ­investment performance than ­annuity rates, although in reality it is the combination of the two that is key.

In a well-constructed drawdown portfolio, there will be a range of funds representing a variety of different asset classes. The annuity buyout yield can be measured at individual fund level rather than the plan as a whole.

This presents a range of ­buyout opportunities based on the ­performance of each different asset class, coupled with the movements in market annuity rates. By capturing gains when ­particular funds have achieved strong growth, the client will benefit from a series of annuities that lock in those gains for life in the form of a lifetime income.

Designing a suitable portfolio is a key aspect of the advice process. Ideally, this will be derived from a discounted cashflow analysis based on the anticipated profile of withdrawals. This takes into account the investor’s expected income needs through retirement, and the interaction of external income sources.

This includes state pensions, ­investment and rental income, as well as other pensions including those of the partner or spouse.

By building a model of the ­client’s retirement, it is possible to establish the expected yearly outgo, which particularly in the early years is vital to protect the drawdown pot against the effects of a severe drop in markets.

The combined effects of ­taking withdrawals from a fund that has dropped in value can be ­devastating on a drawdown plan, and so ­defensive asset classes such as index-linked gilts and ­overseas ­sovereign bonds are critical. These will perform positively when equities and other assets are in retreat.

The overall balance of risk must also be considered, and not simply based on the client’s own attitude to risk. Other factors for consideration include the relative ­importance of the plan taking ­account of the investors’ other income or capital resources, and the anticipated term of investment.

Those clients who are less d­ependent can afford more risk and younger clients can afford more risk than older investors.

The opportunity cost

The reason age is important is because drawdown, by definition, becomes progressively less suitable as the client gets older due to the ever increasing “opportunity cost” of not annuitising.

This is the other side of the ­annuity coin – as mortality subsidy is significantly higher at 75 than 65, what might have been suitable at the start of retirement will be ­considerably less so ten years later.

Just as the initial construction of the drawdown portfolio is vitally important, having clearly defined exit strategies is critical.

This demands an investment process that can be applied consistently across a firm’s drawdown book, linked to client-specific ­parameters, with a view to achieving a transition over a period of years from drawdown to annuities.

Annuity drawdown arrangements can provide a useful intermediate stage in the progression. They offer continuing flexibility and the opportunity for further investment growth, while avoiding the opportunity costs of continuing annuity deferment by virtue of the fact that they also benefit from mortality cross subsidies.

They also extend the investment suitability by many years, providing a  halfway house for older drawdown investors for whom conventional annuities do not meet all their needs.

Steve Patterson is managing director of Intelligent Pensions.

Contact Steve to discuss any of his comments from this article

Posted by: Intelligent Pensions | October 25, 2011

Picking a retirement scheme

Article: Picking a retirement scheme | Publication: IFA Online | Date: 25 October 2011 | Author: Andrew Pennie

Andrew Pennie looks at the options available to generate retirement income and some of the key client factors that should influence the recommended strategy

As a result of longer life expectancy and relatively low annuity returns, there has been a significant growth in the number of products available to deliver ­retirement income.

The three main options are annuities, drawdown or one of a number of different third-way products.

In retirement, clients face a number of key risks, most notably:

  • Longevity risk – living too long and money running out
  • Inflation risk – inability to ­maintain standard of living
  • Investment risk – failing to ­generate real returns ahead of ­inflation
  • Flexibility risk – inability to meet a significant change in circumstance
  • Capital risk – preserving pension capital for next of kin.

As advisers, we are responsible for mitigating these risks on an ongoing basis in a way that best meets the clients’ ever-changing ­circumstances and objectives. ­Traditional ­annuities mitigate ­longevity risk and, for an extra charge, can also deal with ­inflation risk.

Avoiding risky options

Annuities, however, do not ­provide any opportunity for ­investment growth, and thus this should be seen as an opportunity cost rather than a risk. Traditional annuities do little to mitigate the two remaining risks as they provide no ­flexibility and limited capital protection ­options.

Drawdown is considered to be at the other end of the spectrum to annuities. Unlike annuities, they do not completely deal with any of the key retirement risks.

Drawdown is all about managing the risks and an ongoing ­process of assessing suitability against changing client circumstances and external factors.

If appropriate, and managed in the correct way, drawdown can be an excellent vehicle to ­manage all the retirement risks and ­undoubtedly provides the greatest opportunities from a flexibility and capital protection perspective.

Third-way solutions vary dramatically, but generally profess to cover many of the benefits of annuities and drawdown with the drawbacks of neither.

Longevity risk can be partially mitigated, while there is usually an opportunity to beat inflation through investment growth – albeit, investment choice and flexibility is constrained by the need to cover guarantees.

Third-way solutions also normally provide options to address ­flexibility and capital protection, but again with likely compromise over options and timing. 

However, the key to whether this type of solution is suitable or not should largely depend on the cost (or potential opportunity cost) of the underlying guarantee, the likelihood of a client calling on that guarantee, and the impact it would have if they needed to.

Clearly, there are pros and cons for each solution. In some ­circumstances, particularly over time, a combination of solutions may prove most effective to meet your clients’ needs.

Client factors

Every client is different and has different personal circumstances and aspirations for their retirement. In addition, their circumstances will likely change over time – what was right for them last year may be entirely inappropriate now.

It is highly dangerous to ­segment retirement income solutions by ­pension fund value. A host of ­client factors must be considered to identify and recommend the most appropriate strategy. This would include the clients’ age and health, attitude to investment risk, investment horizon available and the degree of dependency on their ­pension fund, taking into account other income and capital resources.

Once in a position of understanding the client’s circumstances and objectives, advisers must continuously advise and avoid pandering to what the client thinks they need. Core ­examples for retirement income planning would include the ­following:

  • Risk: If the client has absolutely no appetite for risk or is not in a position to take any financial risk, traditional annuities are hard to argue against
  • Value: Segmenting solution by fund value can be dangerous. Take a doctor with a high NHS pension and small personal pension, for ­instance – an annuity producing more taxable income is unlikely to be the best solution
  • Guarantees: They can be ­expensive and unnecessary but in the right circumstances these ­solutions can be useful, not least as part of a drawdown exit strategy
  • Phased drawdown: If a client does not need their entitlement to tax-free cash, advisers should strongly recommend that they don’t take it. Phased drawdown is the most ­effective means of adopting a ­flexible and tax-efficient drawdown strategy
  • Drawdown exit strategies: As well as phasing into drawdown, phased exit strategies to take advantage of higher annuity rates because of ­increasing levels of mortality ­subsidy should become a ­consideration as clients get older
  • Health: It is imperative that advisers ­monitor clients’ health and ­eligibility for enhancements where they recommend a ­non-annuity ­solution. Not ­being aware of ­eligibility for higher ­annuity levels is not a defence.

Retirement planning is a growth ­opportunity for advisers, but it ­remains a complex area of advice. It is highly likely that it will be an area of increasing claims risk.

Advisers must ensure they have a robust and consistent advice ­process (in-house or ­outsourced) that clearly demonstrates initial and, where appropriate, ongoing suitability for their clients.

Andrew Pennie is marketing director at Intelligent Pensions.

Contact Andrew to discuss any of his comments from this article

Posted by: Intelligent Pensions | July 7, 2011

Drawdown advice may prove unsuitable: expert

Article: Drawdown advice may prove unsuitable: expert | Publication: FT Adviser | Date: 07 July 2011 | Author: Julia Bradshaw | Quoted: David Trenner and Andrew Pennie

Advisers need to review their drawdown books following pension changes that could make it an unsuitable option for some clients, Intelligent Pensions has warned.

David Trenner, technical director for the retirement specialist, said the increase in tax on drawdown death benefits from 35 per cent to 55 per cent on 6 May could contradict some advisers’ original reasons for selecting drawdown for their clients.

He said: “We know that many clients valued the death benefit and their advisers used it as a justification to go down the drawdown route. The recent change to the tax rules could render the original justification unsuitable. Advisers should ensure that clients are aware of the recent changes.”

In addition to higher tax penalties, drawdown users also face significant cuts to their income because of the the recent reduction of the maximum income they can take from 120 per cent of the old Government Actuary’s Department table to 100 per cent the new, reduced GAD table.

Andrew Pennie, marketing director for Intelligent Pensions, said: “A large percentage of the UK drawdown book is currently in full drawdown with the investor taking maximum income.

“They will not only be hit by the reduction in GAD but will also be hit by the fall in gilt yields and the likelihood that their fund has been eroded due to taking maximum withdrawals. Many clients would benefit from a reality check on where they are going with their retirement pots.”

Matthew Allen, director for London-based Mulberry IFA, said: “Some people who are taking maximums GAD will have a shock because they may not have been reviewed in years and will be hit by both the reduction in GAD figures and also an erosion of their pensions.”

Contact David or Andrew to discuss any of their comments from this article

Posted by: Intelligent Pensions | July 7, 2011

Pension scheme minimises tax liabilities for wealthy clients

Article: Pension scheme minimises tax liabilities for wealthy clients | Publication: FT Adviser | Date: 07 July 2011 | Author: Julia Bradshaw | Quoted: David Trenner

Keith Boniface, marketing director for Brooklands, said Qnups are exempt from inheritance tax and always will be. However, he said the addition of the offshore bond to the Qnups gives clients added assurance that growth on their income will remain tax-free.

He said: “This gives investors even greater protection against any personal tax liability on the money. A Qnups is IHT-exempt, no question. But some tax accountants take the view that HMRC might at some point attempt to tax the income or growth in a Qnups, although it has not done so to date. We believe we have removed this uncertainty by using an international insurance bond.

“The income and capital gains tax benefits of international bonds are well established so advisers and their clients have peace of mind that their assets are securely protected.”

Mr Boniface said any amount of money can be contributed to a Qnups and investors can take out a 30 per cent tax-free lump-sum. Any further withdrawals are subject to income tax at the rate of the country of residency.

However, Mr Boniface said the product was only suitable for high net-worth sophisticated financial investors.

He said: “This is very much for specialist clients and advisers who have high net-worth clients. It’s not for someone who is moderately well-off and doesn’t like the idea of paying IHT.

“We wouldn’t encourage tax dodging or cause HMRC to be irate about it, but we can use the Qnups as a tax advantage for people. The legislation is very clear. We only sell through advisers and are looking to reassure them that this is totally tax protected.”

Mr Boniface added that the company’s tax accountant was available to give advice to IFAs and their clients on large cases.

He said: “The IFA has a duty of care to clients and we have a duty of care to advisers to make this as safe and simple as possible.”

The Qnups is available for UK residents and expats with a minimum investment of £500,000. Benefits may be taken from age 55 or before 55 as a tax-free loan.

However, David Trenner, technical director for Intelligent Pensions, warned that Qnups can be dangerous for clients because many are sold offshore by unregulated advisers.

He said: “Companies such as Brooklands are competent experts, but the message for UK expats is that they have to understand that if they don’t use a UK adviser then they are running into all sorts of dangers.”

Contact David to discuss any of his comments from this article

Posted by: Intelligent Pensions | June 23, 2011

Change to drawdown rules – making good advice bad?

Intelligent Pensions, the retirement specialists for IFAs, are highlighting to advisers the need to review their drawdown book following a change in drawdown rules that could contradict their original justification for selecting drawdown.  The changes relate to the tax on drawdown death benefits which, from April 6 2011 increased from 35% to 55%.

David Trenner, Technical Director said “We know that many clients valued the death benefit and their advisers used it as a justification to go down the drawdown route. The recent change to the tax rules could render the original justification unsuitable. We believe there will be an increased regulatory scrutiny on drawdown advice, particularly due to the change in death benefits and also the removal of the age 75 limit, which acted as something of a regulatory ‘safety net’. There is an obligation to review a drawdown client on an annual basis and advisers should ensure that clients are aware of the recent changes. More fundamentally, they must ensure that drawdown continues to be suitable for each one of their clients.”

Intelligent Pensions are supporting IFAs to manage their existing drawdown business through their ‘drawdown partnership’ offering.

Contact David to discuss any of his comments from this article

Posted by: Intelligent Pensions | June 23, 2011

Drawdown investors could be facing big cuts in income

Due to a surge in drawdown business post pensions simplification as well as the need to recalculate limits on existing plans in the second half of 2006, Intelligent Pensions, the market leading retirement specialist for IFAs, says that a large number of drawdown investors are likely to be facing significant and imminent cuts to their income.

Intelligent Pensions believes that a large percentage of the UK drawdown book is currently in full drawdown with the investor taking maximum income. The changes to drawdown rules, which came into effect on 6 April, will reduce the maximum income from drawdown plans from 120% of the old GAD table to 100% of the new, reduced GAD table. However, Intelligent Pensions says this is not the only driver that could give rise to falling incomes.

Andrew Pennie, Marketing Director said “Drawdown investors who have been in full drawdown and taking maximum income will not only be hit by the reduction in GAD but will also be hit by the fall in gilt yields and the likelihood that their fund has been eroded due to taking maximum withdrawals. This combination of factors could give rise to cuts in income in excess of 30%.”

“Taking maximum income from drawdown was never likely to be sustainable and while a number of solutions are still available that could deliver income above 100% GAD, many clients would benefit from a reality check on where they are going with their retirement pots, and this is where our retirement modelling system can  be highly effective.”

Intelligent Pensions are supporting IFAs to manage their existing drawdown business through their ‘drawdown partnership’ offering.

Contact Andrew Pennie to discuss any of his comments from this article

Article: Retirement Income: the age of drawdown is over, the time of the annuity has come | Publication: CityWire | Date: 10 June 2011 | Author: Lorna Bourke | Quoted: David Trenner

The world is full of advice on how to save for a pension. Much less is offered to those already in retirement, trying to provide a decent, inflation-proof, flexible income from their accumulated savings – while hopefully leaving something for the next generation.

Opting for drawdown

With the recent abolition of the requirement to buy an annuity at age 75, many more people in retirement will be operating income drawdown from a self invested personal pension (SIPP) and take control of their retirement funds.

Research from the Pensions Policy Institute shows that up to three million investors could use drawdown. As companies seek to divest themselves of pension liabilities, an increasing number of pension scheme members are being encouraged to leave with cash bonuses and ‘enhanced’ transfer values as bribes. For lower earners, this is seldom in the individual’s best interest but some take the view that a cash ‘bird in the hand’ is worth more than an income for life – even if it is index linked.

‘The new rules mean investors have more control over their retirement savings and a substantial minority of investors will benefit from this flexibility,’ explained Tom McPhail, head of pensions research at Hargreaves Lansdown. 

He also points out that many more investors are likely to be interested in using drawdown – not just the relatively wealthy. For example employees in a final salary scheme who also have a money purchase pension pot, those who have a partner with substantial retirement savings, anyone who wants to access a tax free lump sum – perhaps to pay off debts or a mortgage – and those who want to preserve assets to pass on to the next generation.

There are however many risks associated with income drawdown and it could leave some with inadequate income in later years. Falling annuity rates and their lack of flexibility has consigned annuities to product Siberia. But, according to pension adviser David Trenner of Intelligent Pensions, there comes a time when income drawdown may no longer be suitable.

Mortality subsidy

 

Trenner is advocating a ‘decade of annuitisation’ when a person in retirement should be considering progressive ‘exit strategies’ from drawdown and a switch to annuities – where the benefits of the ‘mortality subsidy’ can be harnessed. Money used to purchase an annuity buys an income for life and the lump sum is absorbed into the annuity fund. Those who die relatively early subsidise a higher income for those who live longer – hence the ‘mortality subsidy for older annuitants.

Trenner argues that the increasing mortality subsidy renders drawdown progressively less suitable over time and that by making it easier for clients to stay in drawdown beyond age 75, many could unwittingly drift ever deeper into unsuitability.

‘Beyond age 70 the benefits of mortality subsidy start to increase significantly – so much so that at age 80, the benefit could be more than 3% per annum,’ he points out. 

Current annuity rates are around 6% at age 65 but rise to between 8.5% and 9% by age 75. Obtaining a secure investment return of 9% from a risk-free investment is not possible and Trenner believes that, ‘while there are exceptional circumstances where staying in drawdown makes sense, these will not apply for the vast majority. The decision as we see it is not whether to annuitise but when to annuitise and the increase in subsidy over this decade makes it a compelling period to plan individual exit strategies starting from around 70.’

Pensions and annuity firm MGM Advantage takes a similar view. It calculates that at age 70, you could miss out on annuity income of £75,900 if you live a further 20 years or more into retirement. For someone aged 65 the figure is £45,500 but only £12,900 if you live for another 15 years.

It suggests the best course of action is a ‘halfway house’ between drawdown and annuity bearing in mind the best time to switch is generally considered between aged 70 and 80.

Phased exit from drawdown

One solution is phasing the change from drawdown to annuity by transferring part of the fund at regular intervals. ‘Just as we would not recommend a client switches 100% of their fund into, or out of, equities on any one day, it is essential to understand that there is also no one day when a fund should be sold and an annuity purchased,’ says Trenner. 

‘Phased annuitisation, combining conventional and asset backed annuities can be a highly effective approach to deliver ongoing flexibility and investment participation, while progressively securing long term income for the client,’ he says. Asset-backed annuities operate much like drawdown with the purchase money remaining invested to benefit from further capital growth. They usually offer a minimum guaranteed income and also benefit from the mortality subsidy by the addition of extra units in the investment fund as you age.

Making the right decisions on pension assets is a complex business and investors need to consider a variety of different strategies and investment vehicles taking into consideration attitude towards risk and their desire to leave something for their children or grandchildren.

Mix of assets and products

‘We would say a retirement plan should have a mix of assets and a mix of products – probably a portfolio of investments and some annuities,’ says Phil Mowbray, head of retail at Barrie & Hibbert. ‘Everyone will have some requirement for guaranteed income even if they don’t want to give all their money to an insurance company.’ 

Mowbray is concerned that investors will be tempted into drawdown from a Sipp because it gives them access to their savings and that this might not provide sustainable income in later years. ‘What the new rules have done is create a big green light for people to remain invested and not to worry about providing sustainable lifetime income. The fundamental of this is that advisors should be using different product and asset building blocks to construct a retirement portfolio which is aligned with the client’s retirement goals.’

Both Barrie & Hibbert and Intelligent Pensions have analytical tools to help pension advisers construct exit strategies for their drawdown clients. The aim is to help investors understand the options available, measure attitude to risk and come up with a combination of products best suited to the individual.

Contact David to discuss any of his comments from this article

Posted by: Intelligent Pensions | June 6, 2011

Don’t ignore the decade of annuitisation for drawdown clients

Intelligent Pensions, the market leading retirement specialists for IFAs, is advocating a ‘decade of annuitisation’ for advisers to be implementing progressive ‘exit strategies’ for their drawdown clients and thereby ensuring continuing suitability.

The company has been highlighting the potential dangers of staying in drawdown too long following the changes to drawdown rules implemented in April. It argues that increasing mortality subsidy renders drawdown progressively less suitable over time and that by making it easier for clients to stay in drawdown beyond age 75, many could unwittingly drift ever deeper into unsuitability.

The company suggest the annuity decade stretches from age 70 to age 80 and that this period is a reasonable timeframe for the majority of clients to implement their exit strategy from drawdown, some starting sooner than others depending on their specific priorities and financial circumstances

David Trenner, Technical Director said “Beyond age 70 the benefits of mortality subsidy start to increase significantly so much so that at age 80, the benefit could be more than 3% p.a. It becomes unrealistic to deliver annual investment returns that will consistently compensate for that level of mortality subsidy, and while there are exceptional circumstances where staying in drawdown makes sense, these will not apply for the vast majority. The decision as we see it is not whether to annuitise but when to annuitise and the increase in subsidy over this decade makes it a compelling period to plan individual exit strategies starting from around 70.”

He added “Just as we would not recommend a client  switches 100% of their fund into (or out of) equities on any one day,  it is essential to understand that there is also no one day when a fund should be sold and an annuity purchased. Market timing risks make this approach unsuitable and, as conventional annuities are an effective ‘one way street’ for the purchaser, the risk of choosing the wrong basis could cost dearly. Phased annuitisation, combining conventional and asset backed annuities as befits each stage of the exit strategy, can be a highly effective approach to deliver ongoing flexibility and investment participation, while progressively securing long term income for the client.”

Intelligent Pensions has recently launched an ‘Annuity Drawdown’ service for IFAs to deliver robust and effective exit strategies for their drawdown clients.

Contact David to discuss any of his comments from this article

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