Talking to financial advisers, I am often struck by the range of approaches being taken when the build-up of pension assets (accumulation) stops, and income starts being drawn from the fund.
Era of choice
Since the introduction of the pension freedoms, there has been a large increase in the number of people choosing to keep their pension fund invested during retirement (whatever ‘retirement’ means in 2017), and drawing money directly from the fund (income drawdown) rather than buying an annuity to do so.
This is quite rational, as taking the drawdown route offers flexibility and control over the assets. Buying an annuity, by contrast, is a once-only, irreversible decision.
For some people, especially those in poor health and those entering their ninth decade for example, an annuity might still make sense. It offers certainty and a guaranteed income for life.
But for everyone else, thought needs to be given to the investment approach they adopt and, for most retirees, this is something relatively new. Until a couple of years ago, most people would simply have been offered a choice of annuity. The pension freedoms changed all that. So, when thinking about their in-retirement investment approach, what characteristics should savers be looking for?
The investment strategies used in the accumulation phase will be very different, in all probability, to those needed in drawdown.
In accumulation, the emphasis is on growing the capital in the fund to the exclusion of all else. In drawdown, the emphasis is ideally on capital preservation and income production.
I am slightly surprised at the number of advisers who apparently continue with the accumulation approach while also drawing income. In my view, drawdown requires a complete rethink, using an investment approach designed for the job in hand.
The approach adopted in retirement must be economical on charges. If the conventional wisdom is that drawing 4% of the fund value per year, net of all charges, is safe, then an active investment management approach with a total expense ratio of approaching, perhaps, 1.5%, is unlikely to work. Capping costs is vital in drawdown, but is much less important in accumulation provided performance in terms of capital growth is achieved.
The approach also needs to be reliable, as far as possible, in the quantum of income produced, year in, year out. No equity-related investment can absolutely do this, but the investment approach needs to focus on doing so.
The emphasis is no longer on fund performance, but rather on asset allocation and income production while preserving capital or, in cases where gradual capital erosion is planned, ensuring as far as possible that the retiree does not absolutely exhaust the fund before death.
If the money runs out, retirees will be looking for someone to blame. Where this happens, advisers are at risk. Even where the original plan was to deplete the fund entirely, perhaps over a 20-year time frame, and this was documented, and signed by the client, a regulatory risk could emerge. Hindsight is a terrible thing, and the track record of the Financial Ombudsman Service is naturally to side with the client.
These are the salient points savers and advisers need to think about when investing for retirement income. The advice profession needs to be more engaged in the debate about what ‘good’ might look like for retirement income.
Malcolm Small is executive chairman of the Retirement Income Alliance.