This is part 2 or a two-part CPD article about income drawdown.
In 2015 the introduction of ‘pension freedoms’ was a game changer for the retirement income market, moving existing pension savings from a source of income in retirement to a financial planning vehicle, says Keith Richards, chief executive officer at the Personal Finance Society.
Prior to its implementation approximately 75% of individuals converting their pension fund to an income stream entered into an annuity contract, while income drawdown was a much smaller part of the market.
But since the introduction of pension freedoms the situation has reversed, with around 75% of people now opting for drawdown.
At the same time, we are starting to see a change in attitude to traditional retirement, with many people now transitioning into retirement (rather than it being marked by a distinct point in time) and looking at their overall assets, including residential property, savings and pensions, to fund their changing income needs at different points during later life.
While pension freedoms have provided flexibility, such as that inherent in drawdown, it is still the main aim of most people that their pension provides them with an income that lasts through retirement. Indeed, this is one of the reasons the regulator continues to look closely at the retirement income market.
The following, taken from the Personal Finance Society paper A practical guide to advised pension income drawdown, is designed to provide advisers with further commentary and clarification on good practice, given the increased numbers of retirees selecting income drawdown as their preferred retirement strategy.
This article covers points 10-17. Part 1 covered points 1-9.
10. Creating a defined, repeatable process
Scoping out, documenting and following a defined process that is flexible enough to accommodate all types of clients’ current and evolving needs as well as predictable and unpredictable events will help ensure advice remains suitable and compliant.
Such processes should cover onboarding new clients and a robust review for existing clients.
11. Building a robust review process
Successful drawdown strategies require ongoing monitoring to help ensure they meet changing and evolving client circumstances. This requires a consistent drawdown review process across all clients, regardless of the provider.
Critical questions include:
- Is it meeting the stated objectives, priorities and expectations of the client?
- Is the chosen level of income sustainable over the long term?
- Is the investment strategy still suitable?
Other important questions to be asked include, among others:
- How will a client’s health affect the review and outcomes?
- How do you assess whether the clients’ objectives are still realistic?
- Has their capacity for loss/attitude to risk changed?
- How are any changes to strategy and investment portfolio identified and actioned?
- How do you decide if the time has come to consider a partial, phased or full exit from a drawdown plan (eg, to buy an annuity when a client gets older and the impact of mortality drag means their drawdown strategy becomes progressively less effective)?
- Is it clear the clients’ minimum income requirements are still being met?
- Have the client’s cognitive abilities deteriorated?
- Does the client have a power of attorney in place? Or is the client a power of attorney for someone else?
- Changes in relevant legislation?
12. Frequency of review
It has always been important to review drawdown pension funds with clients on a regular basis, but following pension freedoms, and the facility to take large ad hoc withdrawals at any time, reviews have become even more important.
Frequency of review should reflect the complexity of any given clients’ circumstances, but good practice would suggest this should be at least annually and in some cases more frequently.
13. Use of cashflow modelling
A good way of understanding the specific needs of a client is the regular use of some form of cashflow modelling. Good practice should include running cashflow modelling beyond average life expectancy, and the adviser should have a considered position on what that should be and why.
This might also involve further modelling of a client’s overall financial situation to age 75, because at this point it might be better for some individuals to annuitise and remove the risk of outliving their money entirely.
Effective cashflow modelling should stress test various scenarios for the client to enable them to decide whether they are able to take the income they require and how it might be affected by certain events such as:
- The need to increase income taken from a portfolio;
- The need for any ad hoc withdrawals;
- Inflation is higher (or lower) than expected/predicted;
- Living longer than expected;
- Future returns prove to be lower than expected;
- Unpredictable events – a stock market crash, the need to fund long-term care etc.
It is good practice for cashflow modelling to be an integral part of the review process.
14. Building contingency
It is good practice to ensure there is a contingency built in to all retirement planning and to make sure there is significant provision to cover unforeseen problems, such as a major stock market crash, significant unexpected capital expenditure or the death of a partner.
Agreeing to a plan of action in advance will enable action to be taken quickly.
15. Understanding of the impact on welfare and social care support
It is important that the adviser understands the impact of different choices on drawing down pension funds on current and future entitlement to welfare and social care support.
This is especially relevant for those who draw down their pension pot quickly, because they may be deemed by authorities to have deliberately deprived themselves of income/assets and in so doing reduce or disqualify entitlement to such support at some future point.
16. Powers of attorney
As well as increased longevity, the UK will have increasing numbers of people with illnesses, both physical and mental, ranging from mild cognitive decline to dementia.
Good practice involves highlighting the possibility of loss of a clients’ own ability. For instance, if they lose mental capacity what are the issues that present in terms of the ongoing management of a drawdown strategy.
Evidencing that the client has the ongoing capacity to make decisions and outsource decisions to third parties, such as discretionary fund managers and their adviser, is increasingly important.
Clearly the time to set up a lasting power of attorney (LPA) is well before it is needed, and adviser firms should highlight this to their clients.
Consideration should also be given to a disclaimer being signed at the outset if the client chooses not to elect an LPA.
17. Drawdown legacy planning
Pension freedoms introduced the concept of nominee and successor flexi-access drawdown, which among other things allows for pension wealth to be passed down through family generations.
Apart from being good practice, it is important that a member nominates and keeps their nominated beneficiaries up to date if they want them to have access to all death benefit options available under drawdown.
Advisers should hardwire a review of the nomination/expression of wish into every annual review and following each key life event.
Further consideration to involve family and/or loved ones in drawdown legacy planning can mean the whole experience on death goes smoothly and promptly, often resulting in a far better outcome at what is almost always an emotionally difficult time for family members.
Further reading:
FCA acts to stop drawdown retirees losing out
Source: The Personal Finance Society’s A practical guide to advised pension income drawdown – September 2018
