Helen Morrissey talks to a panel of experts about the current market turmoil and how it will affect the income drawdown market
Morrissey: If we start off with the first question. The investment markets are huge news at the moment, and we have seen some substantial falls. Are these volatile markets affecting people's decision to enter the drawdown market and, if so, in what way?
Price: I don't think the current market is deterring people from entering drawdown right now. Any decision to use drawdown is made for the long term; it is not made to invest today to take the money out tomorrow. The key factor for us has always been that the consumer is aware of what they are investing in and that they understand the risks associated with drawdown in any period of market volatility. I have not seen any real change in the volume of drawdown business we are writing. The only change I have seen this year is the increase in people taking tax-free cash and no income. This is in response to the current market conditions.
Morrissey: Billy, are you seeing any kind of change at all as to how people are viewing drawdown?
Burrows: At the strategic level, people are more aware of the risk of drawdown, so people spend a lot more time weighing up the options. However, on the tactical side there are some quite interesting things. First of all, there are a number of clients who have been invested in cash who are now looking to bail out and buy annuities. Equally, there are many people who have been invested in cash who now see this as a real buying opportunity. In the last couple of days, we have had some very surprising calls from what I would regard as very conservative clients who see this as a good time to get into the market.
Morrissey: Is it a case where they think it is the bottom of the market, it is cheap to buy these things, is that what they are saying?
Burrows: I don't think they are trying to guess the bottom, but they are saying that there should be some upturn potential.
White: There are many people saying it might not be the bottom but it has come down a long way so they will take a longer term view on it. They know they will see some short-term volatility but with a 3-5 year view, there could be some very positive upside. In terms of the last couple of weeks, people's decisions have been affected, not just on income drawdown but on everything across the board. People are just uncertain what to do. It is interesting that I was talking to a discretionary manager earlier in the week who said all the phone calls they were getting were about cash and cash deposits. That highlights the uncertainty we have seen over the last few weeks.
The advice process for taking someone into retirement, is not a quick process. You do not see somebody today and they go into drawdown tomorrow. Therefore, as far as the effects of the last couple of weeks, it will probably take two or three months to see whether it has any longer-term effect on people changing their minds. Generally speaking, in our experience, people's view with their pension funds is that they see it as a longer-term investment rather than personal monies, and they are prepared to accept a little more volatility within a pension fund than with personal money.
Smith: I think all of that is totally logical but we have seen in the past, when markets are very high, that drawdown becomes more popular, and when markets fall, drawdown becomes less popular. It may be for counter-intuitive reasons.
White: Exactly. I do wonder whether that is not so much the clients but advisers being wary of talking about those issues. It is very easy to go out and talk positively about income drawdown when the markets are rising, but it is perhaps not as easy to talk to clients about income drawdown when the markets are very volatile or falling.
Smith: The same thing is probably seen with ISAs as well, any stock market type of investment tends to sell well at the wrong time, and sell badly at the right time.
Morrissey: Do you find that much of that is down to the fact that your core drawdown clients tend to have assets elsewhere as well?
Price: Probably like all of us, I would not want to see anybody with their total assets in one retirement product. If they didn't have any assets elsewhere, I would question why they were in drawdown.
White: They should be looking at annuities.
Smith: That is why the amount of money going into drawdown is not relevant, whether a customer has £200,000, £100,000 or £50,000. It is the assets they have in total and whether they can afford to take risks or not that is important.
Morrissey: You mentioned a little earlier on about how people are using drawdown and, Ian; you mentioned that there are a lot of people who are just taking their tax-free cash.
Price: Since A-Day, the split has roughly been around 50/50. This year it has slightly increased. I have been somewhat surprised at how early people are accessing tax-free cash but the need is there. For example, this year we came across a client who needed to make a final payment on a holiday home and had to use their tax-free cash.
Burrows: It's an indication of how perilous people's financial situations are, because I have seen a lot of people want to access tax-free cash to pay off loans or fund mortgages to buy other properties. The concern I have is that people are using their pension for something for which it was not really intended. They could regret later on having spent the cash, because the problem with cash is that people tend to spend it rather than recycle it into income. One of the things we might want to discuss a little later on is how we see people taking tax-free cash from DC pension schemes, as that is quite an interesting area. With personal pensions it is dead simple but it is a little more complex with some of the DC arrangements.
White: Ian mentioned earlier about capital raising. There is an increase in clients taking tax-free cash and maximum income at relatively young ages. Some of it is for capital raising but some of it is being driven by the tax position we have on pension funds. Certainly death benefits and post-75 is concerning people still, and the amount of tax that will be paid if they die post-75 still in income drawdown. In talking to a number of advisers about this, we mentioned earlier that drawdown clients tend to have other assets, and whereas historically you might have taken your retirement income across the spectrum of your investments, they are now looking at taking the maximum income in the early years from the pension fund and almost deliberately running it down while maintaining their capital elsewhere in their personal investments. As long as the adviser is doing that in a stolid way and looking at the clients' assets in the round, I do not see a problem.
Burrows: I believe you can get to the answers by some pretty straightforward logic, and I agree with what you said. If somebody analyses their pensions correctly, they come to the view that they are better off taking as much income as they can from their pension, because every £1,000 from their pension is £1,000 less from their savings, and they are probably advised to think about doing the estate planning through their own savings.
Smith: The other point is that it makes sense to annuitise to protect any inheritance you wish to pass on, as opposed to when we are thinking about drawdown. If you want to leave a certain inheritance, if you annuitise you will not outlive your assets and so you protect the inheritance.
Price: One of the big issues to face us is who carries the mortality risk, and some people still have not quite understood what that could mean with ever-increasing life expectancy.
Smith: The age of 75 tends to hide the fact that the benefit of annuitisation gets bigger the older you get. In your 60s, the mortality cross-subsidy is perhaps 1% so for £100,000 investment, you get an extra £1,000 back, which you may be able to better through drawdown. Once you are in your early 80s, you are talking about 3/4/5% mortality cross subsidy.
White: I think we are all comfortable with the fact that the purchase of an annuity is not a bad idea but getting the timing of it right is what is important.
Burrows: It is much easier to get the timing of the annuity purchase right than the timing of the equities.
Morrissey: If we go back to the issue of tax-free cash, I am quite interested how people are using tax-free cash. Some people say that, if you use tax-free cash to pay off your mortgage, you should use your mortgage payment money to put back into your pension. How can you get that awareness out there that it is not just money to be frittered away?
Price: I think that people should be very aware of the implications when they go and get advice on taking tax-free cash. They might want to completely get rid of their mortgage but you have to understand what the consequence is of taking that tax-free cash.
Burrows: I have no problem if somebody comes and says I have a need for cash, I want to access it. I am very concerned if an adviser is trying to encourage people to release money early, and there have been some quite well publicised problems.
Smith: We have a calculator on our website which tells you what you will lose long term by taking your tax free cash. it is quite frightening to see the impact.
Price: When advising people on pensions you generally say that you will get 25% of the funds in tax-free cash when you get to retirement, so the expectation is there from outset. I agree that when people reach retirement, if they have something specific they want to do with it, then it is fine. However, if they haven't, they still say, "You told me I could have 25% of my fund as a cash sum".
White: What are you going to do with it? I don't know, probably put it in the building society. Well, don't take it.
Burrows: How do we deal with the really cynical people who say, "The reason why I want to take my tax-free cash is because I believe that I can invest it better than the insurance company.
White: Leave it in a SIPP and still invest it yourself, I suppose.
Smith: You are not allowed to take tax free cash out and then invest it in a SIPP.
White: That is what I mean, so don't take it out. You can still do the investment but leave it there.
Price: You do tend to get people who, when they get closer to retirement age, get a bit of a gung-ho spirit and want to have a bit of fun.
Smith: We are also seeing people using each income payment and taking some of that as tax-free cash which is very sensible.
White: We see a high proportion of people taking benefits, going down the phased route, and we have done so for the past couple of years.
Burrows: We have a number of clients who are running phased drawdowns and there is no question that they are tax-efficient but very labour-intensive to advise on. That is the problem with phased retirement, that it works providing the markets are consistent, and it shows the importance of having a proper investment strategy.
Morrissey: You all mentioned earlier on that you were quite shocked by how early people are choosing to take tax-free cash. Can you give me an indication of a rough age?
Burrows: Fifty and above! People ring up and say, "I have just reached the time when I can get my money, can you give it to me".
Smith: Most of ours have been what you would expect - 60 to 65.
White: We have had clients planning to take their retirement for three or four years before they get to 50. Much of it is that people are cutting down and going down to four days a week, three days a week, and part of that is balancing a drop in income from employment against retirement income.
Smith: Flexibility is the key benefit of drawdown: you take what you want when you want.
White: If I look back at the clients who have taken it spot on 50, there are very few of them who have taken it at 50 and stopped, it has been part of an ongoing process.
Price: I think it always has been. Most people will have had to work very hard to build up a big enough pension fund, to totally stop work at 50.
Smith: It gives them flexibility.
Morrissey: Athole, you were saying that you have calculators that can demonstrate the effect of taking tax free cash early?
Smith: It acts as a warning to people to show what the effect will be if they take their tax-free cash too early. It shows what they will be losing out on later on.
Price: Our approach is always to sit down with the client and explain exactly what they are doing as well as go through the illustrations to explain exactly what could happen.
Morrissey: Could we just move on with the agenda and talk about what you perceive as being the main challenges facing income drawdown markets and how you think they can be overcome?
White: From the adviser perspective and the client perspective, it is whether or not we get a major FSA investigation into mis-selling of drawdown and any problems that might create. That might well put advisers off looking at the income drawdown market and whether for many clients it would still be appropriate. Certainly, volatile markets do not help; people take a longer-term view with their pension funds. It is a difficult job for advisers to have to go back to clients and explain that their income may potentially have to drop because of the volatility we have seen in the markets. Longer-term clients still are concerned with the tax regime we currently have post-75. Annuities are an option for clients and a lot of clients are happy to take annuities, but we also see a lot of clients who still want to retain that control and see that they are fit and active and healthy at 75. There are a number of 75-year olds now who are still skiing, still exercising, running, travelling the world, the proportion is substantially higher than it was 15-20 years ago and that will carry on. Therefore, the longevity aspect will cause problems potentially for the income drawdown market if we do not get a change in the tax regime post-75.
Smith: We need to make sure that the impact of annuitising or not is fully understood. By that I mean working out when is the best time to switch from unsecured income to secured income. If the request is to phase it over a period, then we need to make sure that people understand the impact of longevity improvements. In the first 70 years of the last century, there was a 20% improvement in longevity and in the last six years there has been another 20% improvement. In terms of annuity rates, that is worth something like 9-10% in income payments. The impact of not annuitising is something that is perhaps not fully understood.
Burrows: The biggest single issue is to get the investment strategy right. I wonder whether anyone has seen the Investment Management Association discussion paper about drawdown. I received it recently and it is quite interesting because they have done some modelling, and they say their research shows that, if individuals vary the rate that they take income depending on where their funds are going, they will end up with safer investment strategies. The point is that drawdown itself is easy to understand, the rules are pretty straightforward, but the success or failure behind a drawdown plan is directly proportional to getting the investment strategy right. That is the issue with which most people struggle and I am seeing some quite bizarre things. I am seeing some pretty intelligent people going to drawdown and only wanting to invest in cash and, although we explain that, if you invest in cash it is diminishing returns against the annuity, they say they are not worried about that, they want the flexibility.
The other issue that worries me a little is that many IFAs do not really understand the rules, and I can give you a good example. We recently had a case where the son came to me saying his father had died, his mother stepped into the father's shoes with unsecured, an adviser said that she could buy an annuity with a 10-year guarantee and they got nine-tenths of the way down and realised that you cannot have a guarantee. The final point to make is that they need to do something with age 75, because the problem with 75 is that it distorts the advice, the way in which people are advised and it is just a complete nonsense. I understand that we might get 80 but I don't know when.
Price: This uncertainty is clouding the issue at the minute which makes it very difficult for an adviser, as there are so many different factors to consider. I would agree that the investment strategy has to be right as well, because it is amazing how many clients think that if they had gone into cash they would be okay, not realising the long-term significance.
Another observation is that the variety of options now available for retirement makes it even harder to advise. It is quite an interesting process to go through to make sure the clients are fully aware of all the options.
Burrows: I know it is an understatement but, if you analyse it, for what I call middle Britain clients, you have fixed annuities, you have with-profit annuities, you have these fixed-term annuities, flexible annuities, you have drawdown and with drawdown you have subsets of guaranteed drawdown funds, you have insured and so on. Something that I am doing under a separate hat is looking at the advice process that an IFA has to go through. Looking at the advice process, we have identified two aspects that really need to be put under a spotlight. The first piece is helping clients to understand and articulate what their objectives are. Risk is quite a good one because under the conventional way of giving advice, you might ask a client what their attitude to risk is. What we are finding is that the more they understand about the options, the more likely the chance that they may change their attitude to risk.
The other piece that needs looking at is what armoury of tools will IFAs need in order to compare and contrast the different options. I believe that it will go more towards stochastic modelling and more in-depth things like that.
White: The problem is trying to explain it, making sure that the client understands it, and what is right for the client this year may not be right next year. The adviser has to revisit, re-analyse and make those decisions by looking at all the options again. It is not a bad thing but just makes it more complicated and more intensive.
Burrows: The difficulty is that, if you start off from the compliance point of view, as an adviser you have a duty to provide your client with the best advice. How do you explain to a client all the different options in a way that they understand?
Smith: Yes, it is a challenge but it cannot be bad just because these options are there. It cannot be a bad thing to have asset-backed annuities. So that, if you have to annuitise, you do not have to move into bond-backed investments. With asset-backed annuities, you can stay in unit-linked investments. This is a superb advantage for customers rather than having to move from bonds to equities overnight. So these choices cannot be bad for customers.
Burrows: There is a very strong case for it.
Morrissey: As you say, it is good to have the choice providing that (a) the adviser understands it and (b) they are able to describe it to the client in a way they understand. We are talking there about the age 75 debate, do you think that it should be relaxed or removed - do you think it should go up to 80?
White: It needs to be removed, it is a nonsense. It skews advice; it skews clients' perceptions of what they should do. The fact that somebody aged 74 and 364 days is perfectly capable of making their own decisions and investing their own pension fund with help and advice and then one day later they are not capable of doing that is just a complete nonsense.
Smith: I think it is in people's interests financially to annuitise at some point.
Burrows: I wouldn't disagree with that at all. For me, the proviso is that you abolish the compulsion to buy an annuity but that does not in any way change the argument that people should buy an annuity before they get too old.
My contribution to the age 75 rule is I am not sure that the industry has argued its case properly, because the Revenue, the Treasury and the Government are still locked into the idea that "we don't want people saving up pensions to leave them to the children". I think that, if the industry went back to the Government and said what we want is to abolish the compulsion to buy an annuity but in its place we want to have a rule whereby, if you are in drawdown you have to take a minimum level of income so that the Revenue are happy, the Government are happy and you do not have this moral risk of running out of money. It exists in the States when you have minimum withdrawal under 401(k).
White: If the Government is concerned about it, then set a minimum income. If people die, set a reasonable level of tax on the fund, bring it in line with inheritance tax, set it at 40%. People would be happy with that but with the current level at 82%, it is just ridiculous. If they are saying that they do not want people to leave their pension funds to the next generation, the Government on the one hand is constantly saying that there is a shortfall in the next generation of pension fund funding. Therefore, leave it to the next generation but leave it within the pension fund environment. They do not get it as cash, it has to remain in the pension fund environment and it adds to the next generation's retirement planning. Take it whichever way you like but don't just stick a penal tax liability on it.
Smith: The risk to the individual is too great if you do not annuitise. At 85 there is about a one in 10 chance you will live twice as long as your life expectancy. If you do not ensure against that, there is a serious risk that you will run out of money.
White: You still give the clients the option and people sometimes will take the opportunity not to annuitise. I believe that we are all comfortable that for the majority of clients, at some point, buying an annuity makes sense, but clients make a decision based on the information provided to them and they see the penal tax rate after 75, so they are making investment decisions and decisions about their retirement income based around the tax consequences and not what is appropriate for them. That is the main problem with the age 75 rule.
Price: Can I just ask, do we think this will change?
Smith: I do not think that annuitisation will be abolished but the age limit could change.
Burrows: I understand from a meeting I had recently with someone who hopefully is in the know that 80 is looking favourite but we may have to wait until a Conservative Government.
Smith: The other point is that it probably only affects a small number of people and, therefore, it will not be high on any government's agenda just now.
Burrows: One of the issues that has to be addressed is that - I do not know whether this is true or not - people have a perception that pensions are not particularly good value because you have to buy an annuity before 75. If you abolish age 75, will people then start to invest more in pensions? One of the ways in which I believe we can get people to save more into pensions is if there is some feeling of ownership. If you go back to 401(k), there is a feeling of ownership. Anything you can do to give people ownership of a pension fund will make them more attractive, so I believe that it is quite short-sighted for the Revenue to argue this way.
Smith: To get people to save, offering a money-back guarantee for life on an annuity would have a bigger impact. To be able to say to people: invest in a pension and when you annuitise, you get your money back whether you live or die. That would be a very strong, simple message that anyone would understand.
Morrissey: Are you seeing much of a market for ASP?
Price: You have to appreciate that it is still a new-ish market but we are seeing a few high net worth clients with very specific objectives who have gone to ASP, and funnily enough some of it is around the ability to leave money to charitable trusts. There are also some clients where the spouse is much younger, making a joint-life annuity unattractive. So there are niche markets but the wholesale market is not there yet.
White: There is never going to be volume but the people it does affect, it affects them very badly. We have quite a few clients now in both ASP and quite a number of clients using scheme pension to take advantage of changing their income to match their circumstances post-75. There are a number, as Ian has mentioned, who are taking stock of what they are doing with their overall wealth and have taken a view that whatever is left in their pension fund will go to charity, and we have seen a number of clients set up charitable trusts to receive that on the basis that they will use their personal wealth to give to children and their estate. It is an interesting one in terms of scheme pension but, as far as the clients who are currently utilising it, we expect it to be more those who are looking for ill health. We still have the 82% tax rule and clients are still looking to maximise their pension fund where they can.
Smith: We view it as a very niche market, it is not an area in which we have been involved.
Price: I agree, ASP will always be a niche.
Morrissey: If we move on to the next point in the agenda which we have mentioned before, which is the issue of variable annuities and the impact they could have on the income drawdown market. Can you see them taking a big market share from income drawdown, or do you think they will remain fairly niche?
Burrows: The way to start is by saying I believe there are three clear client segments: people with small pensions, what I call middle Britain and people with bigger pensions. The variable annuity take-up will be more in the medium-sized pension funds. There are two issues here. First, there is a strong rationale that, if you ask people what they think about annuities, they will say they don't like them, if they die they lose the money. If you ask them what they think about drawdown, they will say it is fairly risky unless you have loads of other assets. So the variable annuities, or the guaranteed drawdowns as they are better called, if they offer guaranteed income for life with the flexibility of drawdown, there is a strong customer proposition. The devil is in the detail and the detail is (a) in terms of cost and (b) the nature of the guarantee. Cost is dead simple, what I call the incremental cost of the guarantee, if it is 75 basis points, is arguably not over-expensive. The nature of the guarantee is something that is more difficult now to judge.
Smith: That is right. For people in drawdown there are two risks: there is investment risk and longevity risk. To date, most of the products available have been deemed to be complex. The actual charge is fairly straightforward but, once you start to look at what your detailed options are and what you have to do, and what the different circumstances are when the guarantee kicks in, it can be quite confusing. There will be a demand for guarantees within drawdown, especially in volatile markets. Prudential has introduced a drawdown plan that will offer customers the chance to have a five-year lock-in for an additional charge. From the research we have done, this looks like it will be very popular. I would expect the market to offer other guarantees of this nature. As long as they are not over-complicated and the charges are clearly understood, there will be appeal, as Billy says, for the medium-sized pension funds rather than the very large pension funds.
Price: I agree. The biggest question at the minute is who is actually backing the guarantees. That is the interesting thing and people will be very wary given some of the institutions that have been backing them before that were triple A and suddenly were not. I have to agree that I still find variable annuities quite confusing from a consumer point of view. If we can get that simplified, and I am sure the market will develop with the Pru coming in, Standard Life coming in fairly soon. I am far more in the middle, I am not sure if it will erode much of the top end of the drawdown, but for the middle you are absolutely right, and there will be other developments.
White: Our concern is that they are quite expensive. I believe we shall see the products develop. If you talk to the companies where they have originated in the States, the products they now have in the States are two and three generations down the line from the products that we have had launched over here where the costs are less, they are simplified and they offer better value to clients. It will be an interesting one to watch over the next two or three years as the big UK-based companies move into that type of market, and we see products coming across that are later generation options. That will be more interesting for clients than they are currently.
Morrissey: Can we see any room for product development in the income drawdown market going forward? Where do you see the main areas, if we start with you, David?
White: We talked about how it is becoming difficult already to explain all the options to clients. The reality is that it will become more complex as more opportunities come to market.
Smith: The other area where we would see some development would be around what happens at age 75 or 80, as the case may be. Drawdown has now been in place for 13 years and there is a wave of money coming through that has to do something at age 75. I expect that advisers will start trying to come up with solutions to utilise that money.
Price: The key thing is to keep an eye on the market and on what consumers are looking for. We need to make sure that as an industry we articulate what we want in a very positive way.
Burrows: I would say that product development is one thing but in parallel to that, we need to develop better advice and better tools to analyse all of these options.
Athole Smith - Prudential; Billy Burrows - William Burrows Annuities; seated Helen Morrissey - Retirement Planner; Ian Price - St. James's Place and David White - Hornbuckle Mitchell
- Billy Burrows is managing director at William Burrows Annuities
Billy first became involved with pensions when he helped to establish Annuity Direct. William Burrows Annuities was created in 1998 and after a very successful year he was asked to join Prudential Annuities as business development director.
In 2001, Billy re-established William Burrows Annuities and advises private clients on all aspects of pensions, annuities and drawdown.
- Ian Price is divisional director - pensions at St. James's Place
Ian has spent just over 30 years working in the pensions industry. He joined St. James's Place in September 2004 as head of pensions, he is now a divisional director. His role involves all aspects of pensions marketing including corporate pensions, and he presents widely throughout the UK. Ian maintains an understanding of all aspects of the legislative changes affecting pensions in order to ensure that clients of St. James's Place are fully aware of current rules and guidelines. Since 2004 St James's pension production has risen from £56m APE to £172m APE.
- Athole Smith is head of product management at Prudential
Athole has worked for Prudential for over 10 years. He has worked in different areas of the business including customer services and product management and is currently responsible for the design and development of retirement income products including with-profit annuities and drawdown. He is also responsible for Prudential's annuity pricing. Athole is a qualified actuary with over 20 years experience in financial services.
Prudential is a leading life and pensions provider to over seven million customers in the UK. It provides a range of products including annuities, corporate and individual pensions, with-profits and unit linked bonds, savings and investments, lifetime mortgages and healthcare.
- David White is managing director of The Hornbuckle Mitchell Group
David is a strong, results oriented, business leader with vision, energy and clarity of thinking. He has over 20 years experience in the financial services industry, including many years as an IFA. He joined Hornbuckle Mitchell in 1997 where he held a number of roles including operations director and deputy MD before taking over the helm from Neil Marsh in April 2008.
About Hornbuckle Mitchell
Hornbuckle Mitchell has specialised in self invested pensions for 25 years. It has one simple rule: if HMRC allow it, so does Hornbuckle Mitchell. This unsurpassed flexibility has delivered market leading growth rates in the last few years and strengthened its position as the SIPP and SSAS specialist. Hornbuckle Mtichell has recently launched its unique income drawdown product, FIPP (Flexible Income Pension Plan). FIPP offers a broad range of options including income drawdown, ASP, annuity purchase and, for the first time, scheme pension.
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