Drawdown for the over 75s and TCF obligations
75 – still the ‘age of reason’ for drawdown reviews? Andrew Pennie, marketing director at Intelligent Pensions, assesses the advice process around drawdown for older clients and advisers’ obligations under TCF
The government has given people greater freedom of choice about when to secure their pension benefits. But alongside greater freedom comes increased risk and advisers will need to raise their game to ensure they meet their TCF obligations in full.
I recall being told once by an IFA that TCF was simply about giving your clients what they want. It’s not, and furthermore, it’s often the antithesis of good advice. In areas where the risks are poorly understood, good advisers will often find themselves at odds with clients, then, how they articulate what is right and why is the measure against which IFAs will ultimately be assessed. This is particularly relevant to pension drawdown.
Despite the recent lambasting of annuities, they can still offer good value for money in the right circumstances and generally offer better value at older ages for those who can withstand a degree of financial risk in the meantime. This is due to the fact that the rate of ‘mortality cross subsidy’ rises with age. For the vast majority it shouldn’t be ‘whether’ but ‘when’ to annuitise.
When looking at the rate of drawdown an essential benchmark is to test whether, based on their anticipated profile of benefits, the residual drawdown fund at 75, on a reasonable growth assumption, could secure an adequate income in later life, inflation adjusted, using current market annuity rates.
A single life level annuity for a 75 year old, in good health, currently yields around 7.7% p.a., which, of course, is fixed for life. The equivalent yield for an index linked annuity is 5.2%. This is a good way to assess whether clients are over (or under!) spending their retirement fund.
Furthermore, most 75 year olds qualify for enhanced terms on medical grounds and it’s not feasible that such high yields could be achieved from investments without depleting capital. Therefore, drawdown becomes progressively less suitable as clients age, due to the rising effects of ‘mortality drag’ which is, of course, simply the flip side of ‘mortality subsidy’.
Making ‘safe’ assumptions
Ultimately, annuities are insurance policies that protect against longevity risk with the option to insure against inflation risk as well. From the advisers’ standpoint, the only ‘safe’ assumption is that clients will outlive their normal life expectancy, and that inflation will be higher than expected. Even at 65 a male, in normal health, has a 1 in 4 chance of living to 95, while a female in normal health has a 1 in 4 chance of living to 97. For a married couple, both 65 and in good health, there is a 1 in 4 chance that one of them will still be alive at 99! TCF requires such risks to be explained.
For most drawdown investors, ‘best advice’ will be to secure their income in later life. However, no one day in a client’s life is the magic ‘annuity day’. This is likely to require a phased process of annuitisation, striking a complex balance between the particular needs and objectives of each individual client , and prevailing market conditions.
With the changes to death benefits we will see a greater number of pensioners wanting to remain longer in drawdown, and this area of advice will undoubtedly attract greater regulatory interest. Unless it’s feasible to leave legacy pension pots for beneficiaries, without financial risk to the drawdown owners, advisers will need to demonstrate a consistent and robust advice process throughout the post retirement period including drawdown exit strategies and an appropriate de-risking glide path to match.