How can financial planners and the pensions industry support clients in delivering the retirement income they need?
It’s a question that is increasingly being asked, as drawdown becomes more popular and as annuities seem to be locked in an inevitable death spiral.
Drawdown used to be the preserve of a narrower set of people, perhaps with multiple pension pots, who had ready access to advice to navigate what is an inherently complicated market. But the dawn of pension freedoms has turned that on its head, with more consumers looking to drawdown to flex their income in retirement.
So the next question becomes, if drawdown is becoming ‘the new normal’, are we ready for this? Do we need to start having earlier, better conversations with clients about the complex decisions that drawdown involves? Should defaults be used in some way to nudge and help people to manage their retirement income needs, and could defaults potentially have a role as a gateway to advice?
At a recent Illuminate roundtable debate, our panel sought to tackle these issues and explore how retirement planning needs to evolve.
Coping with demand
As drawdown has become more popular post-pension freedoms, advisers and the pensions industry have been forced to try and keep pace with the increase in demand.
More people are moving into drawdown than before, and what’s more different types of people are accessing drawdown than previously.
Intelligent Pensions marketing director Andrew Pennie said he was concerned about those with smaller pots who want to access drawdown but can’t afford advice.
He said: “The one thing we’ve perhaps lost sight of is that drawdown is complicated. It’s not easy to get right and it’s a changing feast. So while I think advisers are geared to cope with the increased demand, they’re geared up to do it for a particular market.
“There are some worrying trends in what’s happening with people using drawdown, and their understanding. Fortunately, we’re seeing that 70 per cent of people get advice on drawdown, and they’re going to be well catered for and well serviced. It’s the 30 per cent that aren’t getting advice who are really open to scams and to making mistakes. Unfortunately, that’s going to end up with people running out of money.
“One of the things we quite often say to people is: ‘Where are you going to invest your money?” They don't think of that. They’re really just using drawdown as a facilitator to access a cash sum."
The Pensions Advisory Service chief executive Michelle Cracknell pointed out that the difficulty is people are entering into drawdown without understanding all the implications.
She said: “With pension freedoms people are looking to access their pot. They don’t want an annuity, for no other reason than they’ve heard it’s bad, so they don’t even consider it, it’s off the table.
“One of the things we quite often say to people is: ‘Where are you going to invest your money?” And the reply is: ‘Oh, I hadn’t thought of that’. They’re really just using drawdown as a facilitator to access a cash sum, and haven’t really thought about the tax implications between the different types of drawdown. They also don’t give thought to the long-term position, around ‘What am I going to do with my fund?’ ‘How am I going to draw it down?’ And most importantly: ‘Where am I going to invest it?’”
Nucleus product technical manager Rachel Vahey argued it is difficult to shape policy for the evolving drawdown market because everyone’s individual retirement decisions are different.
She said: “We are looking at different cohorts coming up to retirement, and they have different needs, different circumstances and different backgrounds. We are also now beginning to see the reduction of the defined benefit pension scheme being the mainstay. That obviously puts a different pressure on what the defined contribution pot has got to do for a person.
“There are so many different circumstances and so many different situations – it’s very difficult to design one policy that fits all for the next 20 years. Unfortunately, to some degree that’s what we’re trying to do, and I just don’t think it’s feasible.”
Alongside the concerns raised about non-advised drawdown, Michelle said there was also an emerging issue around the wave of pensions that are being passed on to others on death.
She said: “The secondary worry we have is someone might have gone into a drawdown product and be capable of managing it, but what happens when they die? Who’s going to pick up the pieces if it’s then being inherited by somebody else? We see this all the time with the phone calls we receive, of people not understanding the retirement product they’ve got, or the product they’ve inherited because their husband or wife has died.
“It’s not just simply a case of sending out letters and telling customers about drawdown, because customers have got to be listening, and I don’t think customers know what they should be listening for.”
Independent consultant Richard Parkin agreed there was an issue around disclosure from pension firms not working effectively. He said this was backed up by the FCA’s own work into non-advised drawdown, which found that providers were complying with disclosure rules but customers weren’t listening.
He said: “What this shows is that disclosure, in terms of sending people bits of paper, isn’t going to work, so we’ve got to find a new way of achieving this.”
Rachel said better retirement outcomes would have to come from translating the complexity of drawdown, such as when people need retirement income and for how long, into everyday life.
She said: “People discuss what the house down the road has sold for, and they should be discussing pension pots and how to start building them up. But actually, it’s much more important to discuss how you’re going to take your money, to be having that open and honest conversation with your peers, and get this into real life. That will start off the realisation for them that they don’t know it all, and that’s the key.”
Of course, you can’t have a discussion about retirement income without talking about withdrawal rates. On this point, Andrew said he was worried about what trends in the FCA’s retirement income data are telling us.
Part of the challenge in protecting clients and consumers in retirement is safeguarding them from running out of money, while also ensuring they aren’t being overly cautious with their pension pot.
Andrew said: “The data shows that more than 50 per cent of people were taking more than 1 per cent a quarter. Now, we talk about the 4 per cent safe withdrawal rate, and that’s kind of agreed that may not be valid anymore, but 50 per cent of people were taking more than that. So, these people aren’t running into problems now, but they will do in three to five years’ time.
“At what point do we stand up and say, ‘Actually, this is a big problem here. People are getting this horribly wrong, and this is going to come back and bite us.’”
Michelle suggested as people aren’t going to understand the issues related to drawdown and managing retirement income at the outset, there could be a role for some sort of “pre-emptive action”, perhaps a safety video that people need to watch when they are considering going into drawdown. She warned if this kind of intervention wasn’t made, the risk was that people would end up “flying without a parachute”.
Finalytiq director Abraham Okusanya agreed, and took the idea one step further. He said: “This is the question I asked the Association of British Insurers when they had the misfortune of asking me to speak at an event. I said to them: ‘What’s the equivalent of your five a day for drawdown advice? What are the things that we universally agree on – the five things that have to be in place when you’re going into drawdown?’ But providers are nervous of doing this for fear of straying into guidance or advice.
“I can’t understand why we can’t come up with very simple rules, like keep costs low, have a reasonable default investment strategy and a reasonable withdrawal rate. The broad guidance that someone needs to get started, that is, if you’re going to go into drawdown here are the five things you absolutely have to think about.”
Abraham added the post-freedoms world where drawdown is more commonplace also required a new way of thinking when it comes to asset allocation in retirement. He discussed how the traditional idea that people at or near retirement should move into defensive assets just doesn’t hold up anymore.
Richard supported this argument. He said: “The real challenge of drawdown for advisers is you move from a world of accumulation where you’re largely focusing on risk in terms of investment volatility, to a world where you’ve got two dimensions of risk, which is the investment volatility on the one hand and then the impact of the withdrawal rate on the other. It’s understanding how those two operate together.”
He added: “That’s where you need to look at things like equity release and other options. Without that backstop, you’re just going to end up being overly cautious and denying people the retirement they’ve saved so hard for.”
Rachel emphasised the importance of reviews for advised clients in drawdown, and argued the focus should be less on sustainable or safe withdrawal rates.
She said: “Retirement income may be a 35 or 40-year problem that people are going to have, and trying to set a policy on day one, I find that really quite frightening. The more I look at it, the more I think there is no silver bullet, there is no safe withdrawal rate. People aren’t going to take 3.5 per cent or 4 per cent and take that exact amount for the rest of their life. That’s the whole point of drawdown – you get less money, then more money, then less, according to what you need.
“So the idea behind it all is reviewing. Review, review, review, that’s the whole secret. Clients have to adjust for what life throws at them.”