Fears are growing that the debated 4% annual income from drawdown is too high and not sustainable in retirement. A one size fits all approach doesn’t work, advisers need to include underwriting at product purchase and at every drawdown review.
SummaryThe worst standard Guaranteed Income for Life rate pays more than the 4% safe withdrawal rate from a drawdown.As clients get older, their appetite for risk may start to diminish. The idea of securing a guaranteed income to secure at least their day to day living expenses becomes more appealing.Everyone has a ‘personalised’ rate through underwriting. A Guaranteed Income for Life rate can be affected by elements such as marital status, height and weight, and even where they live. By personalising the guaranteed income rate this allows it to be secured using less capital and maximise the amount left for investing.
Since pension freedoms, drawdown is now the “cool” option to go for. Although we’ve seen the market for Guaranteed Income for Life (GIfL) provided by an annuity show strong signs of recovery, more retirement clients are still choosing drawdown.
With more people choosing the flexibility of an invested retirement solution, it might sound odd to suggest underwriting needs to fit in. Why would it make any difference to a drawdown client, and how could it affect their choices?
The answer is, underwriting a retirement client to determine their bespoke personalised income from a GIfL could impact many aspects of drawdown planning.
Why underwriting is crucial
Let’s talk about underwriting. Everyone ‘qualifies’. There isn’t really an ‘enhanced’ or ‘impaired’ rate anymore, it’s a ‘personalised’ rate.
Clients can obtain a personalised GIfL rate just from their height and weight (BMI score) and postcode. This means everyone can get a personalised rate.
So, why does this matter for retirees in drawdown if they’ve decided not to use a GIfL?
1. How underwriting affects Drawdown portfolio planning
In the last couple of years, we’ve seen clients with more modest pot sizes who would rather pursue flexibility at the expense of guarantees.
But how many clients have had to compromise their investment portfolio objectives from fear of running out of money during their lifetime?
By using an underwritten GIfL, less capital is required to secure a targeted income and would represent better value in achieving this compared to a ‘standard’ GIfL. But more importantly it’s purchasing some mortality cross-subsidy that they’re lacking and shifting some of the longevity risk away from the individual, over to the product provider.
2. Attitude to risk, capacity for loss
By using part of their pension pot to purchase a personalised GIfL, clients could potentially reassess their investment choices.
It’s probably a safe bet to assume many cautious drawdown portfolios will have a sizable portion in gilts, fixed interest or corporate bonds. By including a personalised GIfL, it removes the need to replicate this through the remaining investment.
This means that the client can re-assess their capacity for loss, as they’ve less investment risk exposure and more security.
3. Safe withdrawal rates
This has been the subject of many articles, with advocates and detractors on both sides, arguing over whether a figure of anything from 2.5% to 4% is sustainable for income provision from drawdown.
Let’s clear one thing up. Even the worst non-personalised standard GIfL pays more than this if the client is looking for a level income. Worth bearing in mind.
Most examples fail to incorporate the effect of charges when comparing to a GIfL. And almost all fail to use a bespoke personalised GIfL for comparison.
A personalised GIfL rate can show the actual level of guaranteed income the client would receive for the rest of their lives.
This advocates that every client should be underwritten at every drawdown review, and indeed at product purchase.
4. Income targeting
If a client is looking to secure some guaranteed income by using some of their invested pension pot, then underwriting means they’ll need less capital to buy the same level of income.
5. Death benefit planning
If you’re including underwriting as part of a review, and the client wishes to purchase a GIfL, having a personalised rate provides some flexibility to build in additional options that might otherwise have been dismissed as too expensive.
The increase to the income rate for the GIfL could be used to offset the cost of including Value Protection or a guarantee period (up to 30 years), which could build in a money back guarantee.
6. Exiting strategies and phasing
There will always be clients whose intention is to use their pension fund as part of their legacy planning. For the majority there’ll come a point where they’ll wish to reconsider staying invested.
As clients get older, their appetite for risk may start to diminish, and the idea of securing a guaranteed source of income to secure at least their day to day living expenses becomes more appealing.
The increase in mortality drag costs start to ramp up after age 70. This means if they’re considering a phased exit strategy to offset this cost, then underwriting can help.
If a client is considering waiting until age 75, but only looking at non-underwritten rates of GIfL income, then they may be able to achieve a similar rate through underwriting but at a younger age. A personalised rate for a 68 year old could be the same as a standard rate for a 75 year old.
Conclusion
It’s easy to see the world of drawdown through an ‘investment-only’ lens. But, when it comes to tailoring a retirement portfolio, the only way to truly ensure clients have a bespoke solution is to include underwriting.
How many drawdown clients would benefit from being underwritten to gauge whether they need to adjust their retirement strategy?
Advisers will also be ensuring they are mitigating the compliance risk to their business. For that reason alone, it’s worthwhile completing the Retirement Health Form in every case.
By including a personalised GIfL quote at each drawdown touchpoint, both the adviser and client are protected by the knowledge that the retirement plan is tailored only to that individual
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