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Creating a robust drawdown review process

Pension freedoms have highlighted the benefits of drawdown but with choice comes risk as well as opportunity, for both advisers and clients. Andrew Pennie, marketing director, Intelligent Pensions, flags five key features of a good drawdown review process

In the pre pension freedoms world, the number of people using income drawdown to provide retirement income was relatively small. However, with a growing backlash against annuities the government decided to take decisive action. Hence, the birth of pension freedom and choice.

This has been great news for professional advisers because the choices are complex while risks are high and there is a growing awareness of the need and benefit of taking advice. To fully harness this opportunity, we, the advice industry, still have much to do to restore consumer confidence and demonstrate we are the ‘go to’ solution for effective retirement planning.

It is inevitable we will see an increased regulatory focus on retirement outcomes and in particular drawdown, where risks are high. In the days of ‘capped drawdown’, many people saw the GAD limits as rubber stamped ‘safe’ withdrawal limits although in reality anything over 100% of GAD max was always pushing the boundaries of the ‘risk and return’ profile needed to achieve sustainability of income and hence suitability of drawdown against a lifetime annuity.

So what are some of the key features of a good drawdown review process?

1. Annual client reviews

Markets, personal circumstance and needs change. Drawdown plans therefore need to evolve and adapt to such changes. If left too long the strategy could be heading in the wrong direction, which can have devastating effects on the long term outcome.

a) Capturing changes in health is particularly important to enable recalculation of the ‘critical yield’ against the relevant enhanced annuity rate to evaluate the ‘opportunity cost’ of staying in drawdown.

b) We use cashflow modelling and update the client model at every review including a check for matching ‘later life’ income requirements, based on switching to an index linked annuity at 75 using up-to-date market rates as a benchmark.

c) Portfolio rebalancing: clients may become more or less dependent on their drawdown fund (for example, if they receive or gift capital) and their attitude to risk can change. Even if nothing changes, the investment horizon diminishes and so the risk should gradually reduce in anticipation of switching to annuities.

2. Regular (e.g. quarterly) investment monitoring to:

a) Make ‘cash-calls’ from funds to meet ongoing income needs, and

b) Rebalance portfolios after any market disruption.

In our view drawdown portfolios are best run on a ‘multi-fund’ basis which mitigates ‘sequencing risk’ and so cash calls should be made as a ‘profit taking’ exercise, thereby capturing gains ‘on the hoof’.

3. Assessing ‘capacity for loss’

This is a hot issue at the moment. For drawdown cases, the investor must understand the impact on their long term financial position of a market crash. Failure to do so could lead to the adviser taking on the risk for the client which is never healthy!

Retirement modelling is a particularly powerful way of helping clients understand the risks they are taking on based on the level of equity exposure recommended. By showing the impact of a stockmarket crash (we use a 30% fall with no immediate recovery) on the retirement model the client can instantly see the long term impact. If they consider this to be manageable (i.e. they have the required capacity for loss) they should then sign-off on the risk and prospective loss. If they are not then they can request lower equity exposure, with a consequently lower growth expectation, and this should also be demonstrated. An annual ‘sign off’ on risk should be a key part of the review process.

4. Exit strategies

Nobody can predict longevity and for many people, the need to ultimately insure against longevity is the only way to guarantee sustainable income for life. Annuities become cheaper at older ages and as health declines, so ‘critical yields’ rise with age or declining health and, therefore, drawdown becomes progressively less suitable, particularly for those who are more dependent on their pension.

In our retirement models we show the position both buying an index-linked annuity at age 75 and remaining in drawdown (inflation adjusted) to see if they are able to secure their required income for life, and alternatively how long it would take for the fund to run out if they stayed in drawdown. The annuity option is considered the ‘default’ and used as a benchmark to assess whether they are drawing down at an unsustainable level.

5. Document effectively

Sometimes, and it is usually only a small minority, clients don’t agree with an adviser’s recommendations, particularly when it comes to looking at drawdown exit strategies and investing in an annuity. However, unless a client can provide a compelling reason why the advice might be inappropriate, an adviser should always document the recommendations and ask the client to write back with the alternative strategy they wish to adopt and reasons for doing so. Treating customers fairly was never about giving the client what they want, however at the end of the day it is the clients’ money, we are only their advisers!

So the new pension freedoms have provided clients with real choice and options for their retirement and the passing on of their retirement wealth. But it does also bring challenges for advisers and it is more important than ever to document recommendations and ensure that you have a robust drawdown review process, whether in-house or working in collaboration with a specialist retirement adviser.

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