Since pension freedoms, many retirees opt to remain invested using drawdown products, electing to shoulder various risk burdens including investment timings, market volatility, and longevity.
Yet when clients move from accumulation to decumulation there are different challenges, including the shift from a focus on risk appetite to capacity to absorb capital and income loss. The central question becomes – how do you advise clients who wish to enjoy a good income in retirement without running out of capital? The answer has been seen in terms of setting a single sustainable withdrawal rate. Just have developed a new Think Report which makes the case for new thinking on this issue.
A change in advice principles
A modern view of capacity for loss in decumulation is derived from a ‘principles’ based advice approach.
Pre-pension freedoms, the amount of funds available drove the product choice, with arbitrary fund limits in place before entertaining drawdown. Below this, and it was an annuity.
This simplified approach doesn’t really cut it anymore, now we see a split between ‘safety first’ and ‘probability driven’. This allows differentiation between retirement goals, requirements for longevity risk management, and evidencing capacity for loss.
Step one is to establish the clients essential spending and ensure this is covered, typically with a guaranteed product which will typically tend to have a lower Sustainable Withdrawal Rate.
Then Step Two - to cover discretionary spending a ‘probability-driven’ approach is required – with funds placed in drawdown and clients talking on the longevity risk and a higher rate of SWR for this element of their capital. The Think Report includes a full case study showing how assessments of capacity for loss cannot be carried out in aggregate but must first look at client requirements for different income tiers.
Looking at capacity for loss in this way in decumulation pins down what the money is really for.
Taking income from drawdown can be complex, and demonstrates the part advisers play in managing client expectations.