Since A-Day, investors have had much more choice in how to manage their 'at retirement' income, says Rob Hudson, managing consultant at adnitor. New products are coming to market to enable investors to take advantage of what income drawdown can offer
Annuities are still the preferred option for the majority of individuals who have to convert company money purchase or personal pensions into income. But those advising on and buying annuities face two problems. First, the income from annuities has fallen in recent years as bond yields have fallen. Second, pensioners are living longer and they need as much income as they can get. In other words, trends in the two inherent financial risks at this stage of life - investment and longevity - have both been on the move.
Sipps have been positioned as the most convenient enablers of income drawdown and this facility has been pitched as an alternative rather than a potential complement to the traditional default choice of annuity purchase.
Income drawdown offers the individual the opportunity to selectively create unsecured incomes from a segmented pension portfolio. This arguably permits a managed and progressive movement from a balanced investment portfolio to an income-creating bond portfolio, while the traditional annuity jumps the investor straight into a lifelong commitment to gilts and bonds. However, the main advantage cited in favour of drawdown is the ability - since A-Day - to manage an inheritance either by encashment on death, or by potential inheritance within a family arrangement.
New products and innovations are coming to market - mainly sourced from the US - that offer defined alternatives to the traditional 'drawdown versus annuity' debate.
A decision whether we need to embrace them is best informed by understanding the nature of the growing 'at retirement' market. In other words, what pension schemes and choices do these clients typically hold, what attitudes do they have towards their pension and is it changing?
Simplification has unified scheme types and therefore made access to differing divestment options easier. Advising on income management in retirement will become increasingly in demand as the baby-boomer generation reach this decision point. A growing consensus is that high-quality 'in retirement' management will use a mix of solutions. Offering progressive, up-to-date and definably value-adding advisory services will grow in importance as this is a large and demanding market.
One of the first myths to debunk is that it is only those with personal pensions who require independent advice. The increasing choice of income options at retirement means company and personal pension holders alike - and many have both - will increasingly require ongoing advice and guidance.
A good starting point is for advisers to offer a pension aggregation statement that is updated periodically and incorporates all benefits - defined benefit, defined contribution, State, protected and so forth. From here a full service can be established.
There are a number of reasons why those with company pensions have less choice than their personal pension cousins. To be technical, occupational drawdown has only limited flexibility because, on death, the remaining fund must provide an income for dependants and cannot be paid as a lump sum less 35% tax as is the case for personal pension drawdown. This means that, in order to benefit from drawdown, it is better for scheme members to transfer to a personal pension - usually a Sipp - although this can be a complex and expensive process.
Those with personal pensions are generally counselled via an existing adviser, who should be qualified to give ongoing services on the full range of options. Most company scheme members take their lead from the options presented by the scheme's advisers, the employee benefits consultants, and often, therefore, they are kept limited and low-risk.
This works well and is appropriate for those with relatively modest sums invested, but there is no reason why those with larger pension pots should not be given the opportunity to consider the ever-growing income universe.
Since A-Day, those with company money purchase funds have had the same options at retirement as those with personal pensions - eight different pension regimes replaced by one set of rules - so everybody has the same choice at retirement. Many members are simply not presented with these choices even though they might benefit from them.
The opportunity for advisers has thus grown significantly and the Sipp remains in pole position to grow contribution levels both as a main pension choice or via 'at retirement' transfers. As detailed above, members of money purchase schemes will find it easier to set up a drawdown, but this will equally be the case in choosing from the array of with-profits, flexible and variable rate annuities being developed.
The attraction of the Sipp is in the freedom it provides the investor and their adviser to tailor their pension scheme to the personal risk profile and current and future needs. Drawdown certainly puts investors in control, but is it in line with their natural risk profile and does it meet their needs?
The major need that drawdown serves is the ability to maintain the investment pot while driving out an acceptable income - even after 75 with the alternative secured pension - and in so doing provide an inheritance. But innovation in the Sipp income market needs to go further if you assess growing attitudes from a changing client base.
Broadly there are two categories of client emerging - those who seek to retain (or wish their adviser to retain) an active interest in managing their finances and developing their pension portfolio (and potential inheritance) up to and potentially beyond their 75th birthdays; and those who seek simplicity and structure in their financial affairs, but would expect flexibility to go hand-in-hand with this.
Arguably the first category is well-served by drawdown and existing Sipp features of flexibility, control and choice. These clients may be looking at phased retirement and will remain actively engaged with their pension. However the second - probably larger - category seems less suited to traditional annuity/drawdown solutions. This is where a lot of the current market innovation in flexible retirement provision is currently occurring. For Sipps to become a core solution for a majority of retirees, they need to be positioned as natural allies to these new offerings.
Variable rate solutions are arriving from the US and mainly targeting this lack of product choice. The concepts and target markets differ for each provider, but many financial service groups with best-selling equivalent products in the US are considering imminent launches.
Generally, savers provide a lump sum in return for a payment of, for example, 5% each year for an unlimited period. The initial lump sum is then invested in a choice of multi-manager model portfolios - index-trackers, bonds or higher-volatility funds, perhaps with lower guarantees and/or higher costs attached. Charges can range from 1.5% to in excess of 2% each year. Commission levels are likely to be attractive as advisers are 'courted' to communicate these new concepts.
Unless capital floors or escalation is provided - a potential option via constant proportion portfolio insurance - the annual incomes may erode the portfolio value if required returns are not met. This opens up the debate about whether these products - and their various guises - are not better served by well-skilled, well-supported advisers proactively managing model portfolios and income levels from them, for their clients via a Sipp scheme.
The reassurances and simplicity of a packaged product, however, fit more closely to the 'category two' client needs outlined above. They may also be more convenient for time-pressured advisers.
Most providers are looking to structure these solutions within a Sipp scheme of their own, and it remains to be seen how flexible the underlying portfolios will be and whether these can be made bespoke to existing in-house models. There is little doubt, however, that these solutions are set to broaden the relevance of Sipp investing to a wider audience and serve the mass 'at retirement' market.
Shredded document in 2013
'If Amazon cannot fix it...'
21-day transfer pledge
Move to Ipswich office
The Value Perspective