Steve Lewis looks at the key issues advisers need to consider when advising clients on retirement income.
Retirement is not what it used to be. Not so long ago, choices for those approaching retirement were simple: you stopped work completely and took out a traditional lifetime annuity.
However, the landscape has changed immeasurably over recent years and retirees have more choice than ever when it comes to turning their pension pot into an income. There are five key things consumers need to know and this is where advisers can really add value.
1. They may not need to retire
Just because they have reached a certain age, or had a load of paperwork from an insurance company, or because their spouse/best friend/man in the pub has told them to, it does not mean clients actually have to retire or do anything with their pension plans yet (unless they want to, of course).
Retirement dates are no longer fixed, and a staggered approach to taking retirement income benefits can be attractive to some.
2. They don't have to take an income
Very often, clients do not know it is possible to just take the pension commencement lump sum (tax-free cash) and leave the rest of their money invested until they are ready to start receiving an income.
Taking tax-free cash early can have a significant detriment to the eventual income that a person receives, so real care needs to be taken.
However, significant tax advantages can be gained through using the tax-free cash for income purposes. For those with larger funds, the consideration of phased retirement is also essential as this has the added advantage of retaining some of the fund in an uncrystallised format which avoids taxes on death.
3. Do they pass the MIR test?
Few clients will know that if they are in receipt of at least £20,000 each year of secured pension income, they will be eligible for flexible drawdown and could therefore use any other pension plans as a lifestyle fund or taxed cash (while still retaining the first 25% tax free).
They probably will not know what counts as secured pension income and what does not, so they will need the knowledge and expertise of an adviser. Conducting the minimum income requirement (MIR) test is the first calculation that should be conducted by any professional retirement adviser.
This is a vitally important part of the process that telephone-based non-advised services have got down to a fine art, with some services boasting up to 60%-70% of clients qualifying for an enhanced annuity rate.
Identifying the current health status of the primary retiree and their partner is critical in the advice process. It is no longer acceptable to just ask if they smoke and feel OK.
5. What risks are they prepared to take with their income in retirement?
Depending on how you phrase this question, a client will usually say “none”. Many advisers still assess the client attitude to risk, and capacity for loss in the same way that they advise the client for a lump sum investment. The trouble is there is no truly risk-free option when it comes to retirement income.
Not all clients understand each of the five main risks to income in retirement (inflation, longevity, changes in circumstances, annuity rate risk and investment risk) and how these impact on each of the retirement income options available to them. This is why they need advice before making a fully informed choice.
Recently, advising on retirement income has increasingly become an either/or decision between level or enhanced annuity and drawdown. There are many more retirement income options available now and for each of the risks to income in retirement, there is a solution to match it.
I believe that phasing or blending a combination of solutions over a period of time will increasingly become accepted practice. As technology improves, it should get easier to obtain all the information and figures needed to advise a client on a range of options.
Improvements in technology should also enable more advisers to provide this level of service on a cost-effective basis to more clients, increasingly regardless of fund size.
But in the short term, the answer is to provide clients with information about all the options available, even the ones you know are not suitable, so they make a fully informed decision and know as much about why they have not selected a particular option as why they have ended up with the solution(s) recommended to them.
LV= has developed Hopscotch, an advice process which advisers can adapt to their own business models. It gives them a framework to guide their clients through the potential risks they face in retirement and the type of products available to mitigate them. Download the LV= Hopscotch app on iTunes.
Steve Lewis is head of distribution at LV= Retirement Solutions
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