There are certain requirements when a firm is making a personal recommendation to a retail client about taking money from a pension.
Firms are expected to consider all of the relevant circumstances, including:
- the client's investment objectives, need for tax-free cash and state of health;
- current and future income requirements, existing pension assets and the relative importance of the plan, given the client's financial circumstances; and
- the client's attitude to risk, making sure any discrepancy is clearly explained between his or her attitude to an income withdrawal, uncrystallised funds pension lump sum payment or purchase of a short-term annuity and other investments.
I think these three statements should form the basis of assessing the suitability of any withdrawal.
Occasionally we hear: “It’s the clients money, they should be able to do with it what they wish”.
While this is true, it's worth going back to one of the first rules in the Conduct of Business Sourcebook, which states:
“A firm must act honestly, fairly and professionally in accordance with the best interests of its client.”
If a client's requesting to withdraw money from their pension for reasons other than retirement, then we need to consider the impact of that withdrawal on their future retirement plans.
This is why having a complete understanding of the client's objectives, state of health, the need for the money and the current and future income requirements is so important for us as a profession in order to form the basis of our opinion.
How we approach income sustainability
When working on behalf of advisers, we typically use a cashflow planning tool to identify what the cashflow looks like without the withdrawal and what it looks like after a withdrawal.
If taking money out is detrimental to the client's retirement plans, then the adviser needs to consider what the client's options are.
Do they really need this money, and what might running out of money mean for them in future?
Of course, any analysis is caveated because none of us has a crystal ball to predict investment returns and future needs.
But having some idea of the impact of doing something is better than having no idea.
The questions that then arise are around what assumptions to use for investment growth, inflation and the age at which the client/s might pass away.
We typically use the Office for National Statistics data for life expectancy.
Where a client has underlying medical conditions, we recommend advisers obtain an enhanced annuity quote which then puts us in a more informed position as to how long the client might live.
Investment growth assumptions vary from firm to firm.
Some people use the FCA’s anticipated growth figures for each asset class, and calculate the anticipated growth for their portfolios based on the risk profile asset allocation.
Yet we have found these rates result in a very low anticipated rate of growth which will rarely outstrip the impact of charges and inflation.
We tend to use the average return of the various Investment Association (IA) sectors of the last 10 years and apply that to our clients' portfolios.
Alternatively we use the IA Mixed Equity sector returns that best matches the client's risk profile.
We believe that so long as you have a documented process, this is an acceptable way of making these types of assumptions.
Inflation is a difficult one.
I was in my early teens in the 1980s, when interest rates were at all-time highs.
To return to this kind of environment, especially given the current situation, seems very unlikely. But with growing debt levels around the globe, could we see a return to inflation at those levels? I hope not.
We tend to average out a combination of both the Retail Prices Index and the Consumer Prices Index to arrive at a meaningful figure.
Here again we believe that providing your process is documented and has some substance behind it, you should be okay.
What's the alternative?
Without wanting to sound like an advert, the online tool from Timeline provides a credible way of demonstrating income sustainability as it allows you to run thousands of different scenarios based on many years of historic market and mortality data.
The output offers a percentage chance of the client running out of money before a particular age.
CashCalc offers a similar tool, as I'm sure do others.
I think without something like this it's very difficult to meaningfully demonstrate sustainability, especially for something like drawdown reviews.
A word on annuities
One of the points the regulator is hot on at the moment is assessing the client's attitude to secure income versus flexible income.
A lot of the problems in this space are around the framing of the questions.
Asking a client whether or not they'd prefer to have their pension money pass to their chosen beneficiaries rather than die with them will only result in one answer.
Likewise, asking a client whether they'd have preferred the salary they received over the past 30 years to be linked to investment returns or to be guaranteed, would probably also only result in one answer.
Having a real understanding of a client's needs and objectives and how they might feel if they were to run out of money - for me this a far easier conversation to have now rather than later.
The alternative is to have it when they are 80 and have to explain that perhaps they should haven’t built that conservatory after all.
Ultimately, this all comes down to knowing your clients. The better we do that, the better outcomes we can create for them.