If critical yield was the key retirement factor, how many 65 year olds would opt for a drawdown plan?
How many people believe that the need to maximise income or minimise tax drives their decisions? And how many would set up a standalone (instead of a phased) drawdown if they were purely looking to reduce their tax liabilities?
Clients contemplating retirement make seemingly nonsensical decisions all the time, so we need to make sure that any irrational behaviour is clearly documented, not just for their sakes, but for your files too.
Advice has to be reliable, jargon-free and wholly justifiable. Particularly where quantitative research points to a course of action different to the one that the client ultimately chooses.
Why do they do it? Could it be that the process is too convoluted and unsettling, and those who investigate alternative plans simply lose their nerve? Maybe phasing is just too complicated and managing a standalone drawdown plan is enough for the majority of clients.
A BIRD IN THE HAND
The question of whether or not to annuitise highlights this uncertainty.
The common perception that ‘buying an annuity means losing everything if the customer dies the next day' encourages an aversion to annuities. Consequently, many individuals consider drawdown which often provides better death benefits than annuities. In fact, because of the tax treatment, phased drawdown can do even better. So if people are keen on protecting death benefits, why don't they go for a phased drawdown?
Is the prospect of tens of thousands of pounds swelling a client's bank account tantalising enough for them to ignore the tax consequences of not being able to phase benefits (lump sum death benefits attract 35% tax - phasing avoids the charge on any un-crystallised element)?
Income paid from the drawdown plan attracts marginal-rate tax. While it's possible to manage the income within the drawdown plan, we rarely see this with income continuing at a predetermined level for as long as limits allow. Phasing allows more effective and accurate income tax planning.
WHO NEEDS FLEXIBILITY?
Research indicates that customers value the simplicity that annuities represent. And as we all know, most people want a quiet, uncomplicated retirement. So why muddy their financial waters by offering investment and income flexibility, and contracts that change to mirror a pensioner's changing retirement needs?
We believe these flexible options are essential. And we believe that retirees believe this too. So why aren't options used more often? Could flexibility be less of a draw than we think? Or do we just stop promoting it once the drawdown proposition is in place?
YOU CAN HAVE TOO MUCH OF A GOOD THING
Many providers make a big deal of the wide range of investment choices offered by their SIPPs. But how is having thousands rather than hundreds of funds helpful to the average customer? As long as there is a good choice of funds in key sectors, that's enough isn't it?
In the past, there might have been a willingness to take some risks with in-retirement investments in order to outperform the critical yield. And though that maverick streak still exists, most people are seeking capital-guaranteed alternatives. In drawdown contracts written today, we see individuals investing in cash. Will they switch out again as the economy picks up? Given their past record with drawdown flexibility, it's unlikely.
WHAT'S WRONG WITH AN INCOME FOR LIFE, ANYWAY?
At the moment, all people only seem to care about is investment guarantees, even though their retirement income might have to last 40 years. And they're prepared to pay for that privilege.
But you can help clients see things more objectively by reviewing the 10 key considerations for retirement planning at their next consultation.
10 key considerations for retirement planning
Income maximisation
Death benefit maximisation
Tax minimisation
Annuity aversion
One-off lump sum attraction
Complication avoidance
Need for flexibility
Desire to make investment decisions
Attitude to risk - flight to safety
Keep paying me forever
These critical factors cannot be created from actuarial data. But you may be able to score them with the client, then map the score (or a combination of scores) to a set of product outcomes. It's not much different from psychometrically-testing investors to establish their attitude to risk.
If people have been setting up drawdown plans to outperform an annuity over the last couple of years, we'll have some challenging questions to answer because the volatility in stockmarkets has meant that divesting from excessive exposures will cause relative financial loss.
Customers need to be crystal clear about why they preferred the investment risk that comes with a drawdown plan, to the safety of an annuity. And why they chose the less tax-efficient, standalone drawdown plan instead of a phased plan.
For all our sakes.
