Aston Goodey discusses the alternatives to income drawdown
The last decade has seen income drawdown become the darling of the retirement income market for mass affluent to high net worth customers. Why? Because it offers everything that traditional annuities could not – income flexibility, death benefits, and access to a range of funds that give income growth potential – all with the same tax free cash lump sum benefits of the annuity.
There’s no doubt that it has served a real need in this market, and continues to do so.
But does it really meet the needs of our retiring population? Would clients have been better off buying an annuity? What happens when customers come to exit drawdown? And given recent market conditions, has it left our retiring population exposed?
The reasons for drawdown’s success still stand. Customers have different income needs in an ever-longer retirement, and those needs are impossible to predict. Having the ability to take a flexible income is essential in order to meet those needs. Positioning themselves for an income that keeps pace with inflation is increasingly crucial, and customers still balk at the thought of losing all of their pension savings on death to an insurance company.
But what are they giving up by not annuitising? Two things – guaranteed income for life and mortality cross subsidy. What’s amazing is that research continues to show that the one thing customers are hungry for are income guarantees – particularly in retirement, and especially the further into retirement they are. Mortality cross subsidy is often overlooked but the value to the customer over time is huge – potentially up to 10% over 15 years.
Mix and match
In finding a balanced solution, many customers have found themselves splitting their pension funds between a drawdown product and a conventional annuity. Until now they have been forced into this ‘mix and match’ approach because there has not been an affordable product that ticks all of the boxes.
For some customers that strategy has worked very well. However, there comes a point when they are either forced to exit drawdown (at age 75), or they feel that it is leaving them slightly too exposed as they grow older. These customers want to continue to be invested in the stock market and take an element of risk, but want some sort of guarantee to boot.
And what about customers with a fund size that precludes them from utilising drawdown (typically customers with funds of less than £100k)? It’s not that they don’t have a decent pension fund, but do they have enough to take the risks associated with drawdown? Arguably recommending a level annuity is taking as much risk – locking into a fixed level of income for what could be 20 to 30 years has all sorts of implications, such as a falling income in real terms.
Customers have been able to increase their income by purchasing an enhanced annuity, should they be unfortunate enough to have a qualifying medical condition. While this gains them a higher income than with a conventional standard annuity, it still remains a fixed level income for life with no flexibility unless an increasing annuity is bought. These tend to be expensive with low income in the early years. Forecasts for annuity rates are downwards following the implementation of Solvency 2, with some commentators saying this could be by as much as 20%.
So what is the answer? The good news is that innovation in the retirement income market is such that a polarised approach to retirement financial planning is becoming old fashioned. There are options out there for you and your clients that offer holistic solutions that can flex and adapt through the life of your client’s retirement and take into consideration health conditions.
The investment backed annuity is not a new concept, but existing products have often been perceived as complicated, opaque and expensive. Recent innovations have meant that there are products out there that can demonstrate the opposite. They are also RDR friendly, allowing you to move to a sustainable revenue generating model – something the traditional annuity will struggle to achieve.
Drawdown absolutely has its place in the retirement income portfolios of many customers, but it cannot be all things to all men, and really should be used to address the needs of the customers it was originally intended for – high net worth individuals.
For many people, there are now affordable, flexible, transparent alternatives with lifetime guarantees that are designed for the everyday person entering retirement.
Aston Goodey is sales and marketing director at MGM Advantage
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