In our new series of ‘Let’s Talk Retirement’ we’re tackling some of the more thought-provoking aspects in the challenging realm of retirement income advice.
In the first episode, Adrian Boulding, Chair of Spire Financial, shared his insights into the annuity versus drawdown debate. Watch here if you missed the live stream.
Annuities are back in the spotlight...
…and deserve to be carefully discounted when considering drawdown.
Why? Because the interest rate reversion since 2021 means annuities are once again a credible alternative to drawdown for the less well off, for the more risk averse, and those beginning to lack the ability to focus on their affairs.
Also, Consumer Duty requires advisers to consider and avert foreseeable harm, above all running out of money in old age. Annuity offers complete certainty of lifetime income – at a price. Guarantees are appealing to many, either out of caution or because they can comfortably afford the option.
Longevity is still projected to rise, despite COVID. For the cohort of men and women approaching retirement, more people can expect to become ‘super centenarians’ - living to 110. This means the risk of living to an extreme old age is going up.
Advisers will be alert to the benefits of medical underwriting which can boost income from annuities. And to the fact that annuity rates fluctuate – not only as a result of changing interest rates, but as a result of supply being under the control of insurers. This can create meaningful timing opportunities. There’s also modest income benefits for women buying annuities because of single gender pricing.
Drawdown offers opportunity and flexibility...
…but with investment risk and ongoing complexity.
Regulation demands an annual reassessment of suitability. This works well with the reality of retirement which is a bigger a period of change than those still at work generally imagine.
Advising someone to accept the opportunities (and risks) of drawdown, means clearly understanding how likely it is they can achieve the income they need if they live to extreme old age. Although that challenge is taken care of for many by secure income, whether that’s from state pension or defined benefit (DB).
It follows that advised drawdown needs an analytical assessment of capacity for loss. And there’s a requirement for the client to sustain their level of financial capability for drawdown to remain appropriate.
Research suggests that the often-reported decline in spending through retirement may not be what it seems. ‘Younger’ cohorts seem to have established a more expensive lifestyle and may not tolerate the drop in living standard they would suffer for them to live at the same standard as the ‘older’ cohorts. This may be linked to a difference in spending patterns, for example around consumer technology.
Advice supports people making decisions and managing plans
There’s every reason to consider a ‘mix and match’ approach to annuity and drawdown, where appropriate. Both options are useful tools in the adviser’s kit bag and can be combined to sustain security of minimum income.
There’s some evidence that taking partial annuity early, treating that as a defensive asset allocation call, and then adding to the level of investment risk in the remaining drawdown pot gives a chance of a better outcome for clients.
The overall level of a client’s wealth is probably a good a rule of thumb or helpful guide to how likely an annuity guarantee is needed, as recently suggested by Adrian in his recent article.
Setting the drawing level annually with one eye on the annuity rate, rather than modelling out a fixed withdrawal, means you know you aren’t implicitly taking the risk of exhausting the pot. You’ll always be taking a proportionate shaving not an absolute amount. Adrian’s rule of thumb is 4% at 60, 5% at 70. Given that advising on drawdown is a ‘one year at a time’ process, this can and will be adapted as circumstances and portfolios change.
Looking to hedge out sequence risk with a high cash balance comes at the theoretical cost of a lower long term return but can be a valuable source of client composure.#
The retirement income market is evolving.
The potential of Collective Defined Contribution Decumulation-Only Arrangements (CDCDA) to launch within a couple of years may be some reason for individuals to defer big decisions on annuitisation. CDCDA may offer a halfway house between the two current options. Offering the same initial income as a level annuity but, all things being equal, ongoing increases to keep pace with inflation. And greater certainty that the income will last for the whole of your life, from the sharing of mortality credit.
Join us for episode 2
Episode 2 of Let’s talk retirement 2.0 kicks off at 11AM on November 24th. I’ll be joined by the Lang Cat’s Tom McPhail where we’ll be discussing ‘What’s next for pensions?’.
This article is for financial professionals only. Any information contained within is of a general nature and should not be construed as a form of personal recommendation or financial advice. Nor is the information to be considered an offer or solicitation to deal in any financial instrument or to engage in any investment service or activity.
Parmenion accepts no duty of care or liability for loss arising from any person acting, or refraining from acting, as a result of any information contained within this article. All investment carries risk. The value of investments, and the income from them, can go down as well as up and investors may get back less than they put in. Past performance is not a reliable indicator of future returns.