Traditionally when retiring an annuity was purchased providing income throughout life providing longevity protection with over 700,000 pension holders accessing their pots, 17% of which have purchased some form of an annuity, not that surprising I hear you say. However, annuities purchased from existing providers (clients not using open market option) are still hovering around the 50% levels, although this has fallen from 90 plus percent a few years ago. The facts that more than 700,000 have accessed their pension via the freedom rules with drawdown now dominating the DC space.
With over 3m people aged between 55-75 with access to DC pots and of which 2.1m investigating their options, it is clear that drawdown will continue to be a more favourable option in the years ahead. However, the understanding of drawdown is still a concern when you look at bit closer at the data.
A survey by the Pension and Saving Lifetime Association (PLSA) stated that client’s primary objective was not to run out of capital as their biggest concern. This highlighted the complicated and perhaps impossible mix of features that are preferred:
1. Having the flexibility to change the product they used to take their pension when they wanted to;
2. Not running out of money in later life / receiving a guaranteed income throughout their retirement;
3. Minimising the risk of losing money even if it meant little chance of gain; Leaving some money aside for later life.
So how can these be balanced, I think we will be making a call upstairs for some divine intervention. The understanding of drawdown is unclear to the vast majority with around half thinking drawdown provided a guaranteed income for life. As financial planners, we need to educate clients on the consequences of poor decisions.
Education is the best provision for the journey to old age: Aristotle
Further supporting evidence indicates that DC pots accessed by clients who withdrew 25% or more placed these funds in a Current Account (18%), Savings Account (23%), Cash Isa (20%) Equity Isa (19%), with a total of 61% invested in cash holdings.Was there a need to withdraw the capital in the first place? The remaining 20% had been used to pay down debt, clear mortgages, purchase new cars, as well as going on holiday.
In today’s market, very little attention has been given to the decumulation phase, responsibility has now shifted to customers and their advisers to manage the principal throughout their lifetime, retirement income strategies now play a vital role in educating clients on how to handle retirement planning.
Clients have to determine how much income they require to support their lifestyles with a focus on longevity and all the associated risk that come with staying invested in the market. Moreover, many discussions on how to tackle the income in retirement and what constitutes a safe withdrawal rate continue to be debated.
William Bengen was a financial adviser from across the pond who devised the 4% rule of thumb and developed the term “Safe Withdrawal Rate” (SWR) in 1994. His research looked at a starting rate of income of 4% from 65 increasing by CPI each year which would be sustainable with a probability of 95% in retirement for a term of 30 years. His theory was based on a 50/50 split between equities and bonds providing the desired income.
However, is this fit for purpose in today’s low yield environment?
There are many rules of thumb from taking the natural yield to adopting Bengen theory but what is that magic number? Is there a specific percentage that can be used as a baseline to help clients achieve their desired objective? I think this figure is well below what Bengen indicated.Within the FCAs “Retirement Outcome Review” indicated that 71% of people were accessing their pots before 65, there is a clear issue awaiting on the horizon – a more impoverished later retirement for many.
Research gathered from 56 providers indicated that people with fund values of more than £100,000 were withdrawing income of between 4%-7.99% per annum 34% and 21% drawing more than 8% per annum, this is unstainable in the long term. We have to be transparent with clients that there needs to be a disciplined approach to withdrawals and managed annually as part of the review process.
Some years may be great, some not so, lifestyle adjustments will be necessary to maintain the desired outcome and income.So, what is the perfect combination to this challenging puzzle, it is clear that withdrawal rates as reported by the FCA cannot continue at the current levels as this will lead to premature ruin for more than half the current clients in drawdown?
Further research on the UK market indicated around 3.26% per annum seems to be an appropriate level to maintain the income for life with a high probability of success.
Adopting a more conservative holistic approach will provide the flexibility that clients desire throughout retirement, however, the question remains will 3.26% be sufficient for clients to meet their needs in retirement today -better safe now than skint in your old age.