Compliance Matters 13th September 2024

Autumn is upon us, the Oak Tree outside our house is starting to acquire the tinge that tell us it is getting ready to shed its leaves.  This week, I highlight some important considerations when discussing income in retirement with your clients.

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• Firms encouraged to explore new approaches to increase pension engagement

• How well do you use cashflow modelling?

• Risk and retirement planning

  
  

Firms encouraged to explore new approaches to increase pension engagement

The FCA has carried out research to improve communication with consumers to help them make informed decisions about their retirement savings.  The research, once again, uses behavioural insights to create and test different email designs and subject lines.  It aimed to overcome common barriers, like the tendency to focus on the present rather than the future (known as present bias) and feeling overwhelmed by too much information.

The research also sought to test effective touchpoints for engaging consumers about their pensions.  It tested whether sending an email around notable touchpoints, such as a birthday, would increase engagement.  The news release summarises the research.  Further detail about the research can be found in Occasional Paper 65.

The paper explains the results from the research into whether a communication’s timing makes it more likely pension customers would engage with their pensions.  The research found:

• Engagement with emails was low.  While around 42-55% opened the emails just 1-7% clicked through to 'call-to-action'.

• Older customers were more likely to engage overall, but no key life point was particularly effective at increasing engagement overall.

• Following up with those already engaged with their pensions was more promising in driving further engagement and use of online services.

How well do you use cashflow modelling?

In March of this year, the FCA published its Thematic review of Retirement Income Advice which received a lot of attention.  Some firms are still getting to grips with the use of the Retirement Income Advice Assessment Tool (RIAAT) when discussing retirement options with clients.  Alongside the thematic review came a document asking firms to review how they use cashflow modelling.

The key to using cashflow modelling is to use realistic assumptions in relation to inflation, the growth of assets and the rate of withdrawal.  You also need to ask your clients to assess realistically their income needs in retirement.  Some current expenditure may cease on or prior to retirement, these may be replaced by new expenditure.  Are there any lump sum expenses that need to be accounted for?  And then there is the big unknown of will your client require long-term care in very old age.  All this will point to the sustainability of your client’s assets throughout retirement. 

Retirement income is not simply about drawing down pension funds, it is about the most effective use of lifetime assets.  Your client may have wealth in ISAs, GIAs and pension funds.  They may have guaranteed income from defined benefit pension funds and the State Pension to give income that covers some or all essential expenditure.  Consideration of the tax regime at the time of the advice will inform the order that you recommend your clients decumulate their assets.

In today’s Professional Adviser, Nick Eatock, CEO at Intelliflo writes about the power of cashflow modelling.

If you want to discuss the use of cashflow modelling in retirement planning for your clients, schedule a free, no-obligation consultancy call with us today. 

Risk and retirement planning

A new white paper from Chancery Lane examines the limitations of modern portfolio theory.

The white paper ‘How to Retire Well’ delves into a number of areas, including volatility as it relates to dividend income, the limitations of modern portfolio theory, and the merit of a natural income approach to retirement planning.

Traditionally the zero per cent equity portfolio would have been seen as the least risky and the 80 per cent equity-heavy portfolio the riskier, however this has not been proven by the historical results, according to Chancery Lane.  Doug Brodie, chief executive of Chancery Lane, said: “We have no opinion, simply data and what this demonstrates is that the capital cost of moving from ‘probable’ income to ‘guaranteed’ income for retirees is huge.

“The other incontrovertible message is that income is not positively correlated to capital values.  This is counter intuitive and something even the FCA struggles with.  However, income from a share is decided on twice per year by a Board of Directors using cash they already have - whereas capital values are a simple reflection of this morning’s share trades.”

In forming its views, the authors carried out a comparative analysis of alternative income drawdown strategies between 1986 and 2023, comparing low-cost index tracking, 60/40 equity/bond portfolios, and natural income strategies.

The paper said using volatility as the main measure of risk can be misguided, as while it is a valid measure, the risk is not one of fluctuation, it is a risk of an adverse behaviour.

Chancery Lane said the two biggest risks for an individual depending on drawdown income are sequence and longevity risks, which can be removed by investing for natural income via assets with a cash buffer, such as investment trusts.

“Seeing the value of their savings fluctuate will make any investor anxious, but even the risk-averse may prefer some turbulence to the possibility that they may not have enough money to live on in retirement,” the paper states.  “Believing that a downward fluctuation in diversified savings will create a loss is irrational, albeit an enormously strong emotional belief.”

According to the research house, evidence suggests that equity volatility is “a risk well worth considering”, particularly if the asset class is represented by a well-chosen portfolio of investment trusts.

Investors may face less volatility of income with such a portfolio than they would with a classical modern portfolio theory-based one of 60% equity and 40% bonds.

Sequence risk is the most destructive risk when an investor is drawing income, and that risk is removed by using natural income, according to the researchers.

“We think the simplicity of the natural income approach is more predictable, more valuable and – ultimately – more reassuring for investors, particularly those retired,” the researchers said.  “It meets what is required by most pension drawdown investors: an income for life, rising each year to counter inflation, with a good degree of certainty.  The outcomes meet investor expectations.”

According to Chancery Lane the industry needs to redefine risk for equity income because volatility of income is “quite different” from that of share capital in a trust.

“An issue we’ve been asking the FCA to resolve is that they and the industry still follow the Brussels missive that risk is defined as the level of volatility which mis-defines the risk in equity income,” explained Brodie.

Another conclusion of the whitepaper is that in a DC scheme, income should come first, as with DB schemes.

Brodie added: “Our objective is simple data analysis, recognising that while in accumulation of pension pots people often have the luxury of ‘adjustable timing’ to soothe and smooth their pension pots.

“However, pension income is binary – its either there or it is not.  The issue of how a pension is invested and what percentage should be withdrawn does not occur with DB schemes but in a DC scheme the pension pot is exposed and in most circumstances, we suggest these pots should also be income first.”

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