Conjecture: Innovation in retirement income

Retirement Planner’s Helen Morrissey recently chaired an online Conjecture debate on income drawdown.

Panel participants were John Moret, Mike Morrison and Billy Burrows. To listen to the debate log on to www.interactivefinancialadviser.brighttalk.com

Before I kick off the debate, I’ll start the first of our polls. The question that we want an answer to is, will the government’s proposals deliver the freedom and choice that Mark Hoban, financial secretary to the Treasury, has suggested. Your options are: yes this kind of reform has been much needed for years; number two, yes but it needs further work; and number three, no there is still limited benefits to the majority of retirees.

How do you feel about government proposals to abolish the age 75 rule? Do you think it is the best thing to happen in the retirement market, or do you have reservations?

John Moret: I am delighted that finally we have got the flexibility that is long overdue. Whether it is the best thing to have happened to the retirement market I am not quite sure. I do have a few reservations, particularly around the complexity that may still exist, and perhaps my biggest concern of all is the need for education.

Mike Morrison: We have got the framework for flexibility, but to me it is about filling in the details and whether it will actually add value for the majority of people. I still think for the majority of people the most suitable form of retirement income will be an annuity and we do need to make sure there are no real unintended consequences, and what we end up with is a framework that delivers what consumers want.

Billy, how confident are you that the proposals will be adopted? Do you envisage changes being made at the end of the consultation period?

Billy Burrows: I think the two things up for real discussion are the minimum income requirement and the maximum income for capped drawdown. So, I’m fairly confident it will happen, when I think is another matter. I’m 100% behind extra flexibility and abolishing the effective compulsion to buy annuities at 75. There is a concern you may well end up with investors taking more risk than is good for them and potentially ending up in a worse position.

As you say, one of the big issues coming up in the consultation is what level this minimum income requirement should be. Would you hazard a guess as to where you think that should fall?

Moret: Personally I’m not in favour of a minimum income requirement; I’d much prefer to see a minimum capital requirement because I think that’s a whole lot easier. I’m concerned the current proposals are quite complicated and there are a number of questions in the consultation document that need to be answered around not just the level, but the extent to which it’s inflation proofed. Whether you have age related minimum income requirements, how often minimum income requirement needs to be reviewed, and I just see that becoming unbelievably complicated, unnecessarily so. But if they stick with minimum income requirement, and despite my misgivings I think that’s probably what we’ll end up with then I just hope we get something that is simple.

Morrison: Some of the discussions I’ve taken part in have mentioned perhaps it needs to be a percentage of the national average earnings. But again there’s complexity of how you adjust it. The Irish approach which has been about holding a capital element, I think the last time I looked it was €63,500 seems to be a more logical approach. It does seem strange that one of the solutions to removing compulsory annuitisation may actually be the need to buy an annuity to secure a minimum income.

Do you think the need for a minimum income requirement means people will split their income between annuities and income drawdown.

Burrows: Oh yes. I think that the first point to make is that we’re going to have the law of unintended consequences. You have the scenario where somebody’s got a final salary scheme that will take them above the minimum income requirement. Then they’ve got a small personal pension, £20,000, £30,000, £40,000, £50,000 that can be taken as an income payment. The best advice for many people will probably be something along the lines of starting off retirement with as much flexibility as is appropriate, and then as time goes on, buy annuities as the investor wishes to reduce their risk.

There’s been a lot of discussion around the death benefits associated with this proposed new regime. Under the proposals any unused funds on death are to be taxed at 55% if the individual is over 75, but would be tax free for those who have not accessed their pension savings if you die before age 75. Do you think these new arrangements could become a bit of an IHT loophole?

Moret: I don’t know a loophole. I think it is a step forward from where we are to have a consistent treatment. Whether 55% is the right level I think is up for debate, the government have sort of pitched that on this basis it’s tax neutral so they say. Clearly there are still, and will still be anomalies in that you still will have a big difference between the situation if you die and you haven’t taken any benefit, and the situation if you die and you happen to have gone into capped drawdown. On the IHT issue you could argue that it would make sense for the rate to be the same as the IHT rate, but that wouldn’t actually work I don’t think. All I would say I think, that this is better than the regime we have at the moment.

Morrison: There’s a bigger point here which is pensions are to provide a pension income. I know my customers well enough to know that on the one hand they’ll say, yes we want a secure income for life. On the other hand they say, you know, when we die we want to leave money to the family. The truth is you can’t do both. So, I would have thought that the 55% tax is at a reasonable level, but I think under closer scrutiny, an adviser and a client should work out there are advantages in buying a joint life annuity because it delivers income for life and if they really do want to provide death benefits then they know how much tax is going to be paid.

Moret: I’m not sure that I agree you can’t have both. You clearly can’t have both in the sense that you can have maximum both, but I think, what this is going to encourage is use of different products and approaches to optimise both capital preservation and income optimisation. I don’t see anything particularly wrong in people wanting to preserve capital within their pension. We’re moving to a regime where in the pension savings environment, people are on their own so why shouldn’t they look at their pension savings as part of their overall capital and wealth?

I’ll give you the results of our first online poll. The question we asked was will the Government’s proposals deliver the freedom and choice that Mark Hoban, financial secretary to the Treasury has suggested. The answers are: 21% of you thought, yes it’s a kind of reform that’s been needed for years. 71% said yes but it needs further work, and 7% said no this delivers limited benefits for the majority of retirees. Mike, would you like to comment on those?

Morrison: We need to work on the framework; hence I think the 70% saying it’s a good start but let’s wait and see what we get.

In 2008 many investors in income drawdown watched in horror as falling stock markets savaged their pension pots. Markets remain volatile, so do you think this is really a good time to put clients into income drawdown solutions?

Morrison: I think the key issue is to make sure that people go into drawdown knowing there are risks, and that they set their income limits in accordance with their tolerance to investments. It really is an advice-heavy process, and advisers do need to make sure that having put somebody in a particular investment strategy that portfolios are re-balanced, that changes in the market are addressed and it’s an ongoing advice process.

Moret: This is all about risk, and annuities have different types of risk. It’s not just about investment risk, you’ve got inflation risk, you’ve got interest rate risk, you’ve got longevity risk, you’ve got mortality risk. It’s complicated, and consequently I see a situation where there will be much more use made of blended solutions.

If I just start off the second of our online polls. The next question I’d like our advisers to answer is, do the tools available from providers, to manage income drawdown for your clients, meet your needs? The options that you have are: no this area needs immediate attention from providers. The second option, no I use my back office system. Number three, yes they do the job with some manual input, and number four, yes the available tools are sufficient. My question to the panel is: ‘Annuity rates are at a 20 year low and this begs the question, should anyone with a decent pension pot really be buying an annuity when a carefully invested portfolio could deliver a better income?’

Burrows: One of the things I find fascinating is to look at what my clients do. My clients who are actuaries, investment bankers, stockbrokers do, compared to what politicians and people in the media and architects do. The answer is that people that understand risk take very little at retirement and will often buy annuities. Those that don’t understand the risk may well go into drawdown. So, I think the answer is that, yes, there is a role for annuities, but I think the serious point about rates being at an all time low probably means that for a lot of people putting all of their money into an annuity at younger ages isn’t necessarily the right thing. So, we’re back to a combination of annuities and drawdown over time.

Morrison: I think the thing about it is if annuity rates are at an all time low, and it’s taking more money to buy a specific level of income, that just reiterates the need for people to save more in the first place. If their money’s got to work harder, and looking at annuity rates you need perhaps twice as much now as you did in 1994 to produce the same level of income.

We have a question from one of our listeners: ‘In the age of the internet why can’t I get an online statement of what my client has paid in and what’s been paid out?’

Moret: I can’t speak for all providers in terms of what they can and can’t do, but I think the question has a lot of merit. The advancements over 15 years in terms of the technology of delivery of drawdown have been pretty limited. As an extreme, why shouldn’t you be able to actually drawdown cash through an ATM machine? That was talked about some ten years ago but it’s never happened.

Burrows: I find that quite a strange question because, of course, you can. I’ve been using various providers where you can go online and see the whole transaction. You can even see the rebate from HMRC for the tax release. So, I think the answer is if you look around there are SIPP providers who are providing that information online at the moment.

Morrison: In an age of increasing technology with wraps and platforms and the interface with advisers and clients, there are providers out there that can do that. As retirement planning develops over the next few years I think the technology side will hopefully move on apace.

Before we move on to the final part of our debate I’m going to give you the results of our second vote. Do the tools available for providers to manage income drawdown for clients meet your needs? 56% said, no this area needs immediate attention from providers. 8% said no, I use my back office system. 28% said yes, they do the job with some manual input, and only 8% said, yes, the available tools are sufficient.

Moret: I’d say I rest my case really. I’m a bit surprised it’s quite as dramatic as it would appear to be, over half saying they get virtually no support from providers. I think what it reflects is there’s been a huge focus on the accumulation phase. Those platforms by and large haven’t really tackled yet the post retirement market place in terms of offering the technology in the way that they do on fund selection.

Where do you see third way products fitting into this market both now and in the future?

Morrison:  I think if we look at the spectrum with one end the absolute security of annuity, the other end being the flexibility of drawdown, somewhere in between there I think there is a third way market. I think we will see part of this innovation in the different ways of providing different guarantees, different ways of maintaining capital and providing income guarantees.

Burrows: There’s a very strong customer proposition with these products. People want a secure income for life as well as flexibility and you can combine these within a variable annuity. I think the problem is in the complexity and the cost but I think as more companies come in to the market and there’s a better understanding then we’ll see them gaining more traction.

Moret: I was just going to say if you look at independent analysis of these types of products they certainly have a place. I think at the moment it’s the transparency of the product which is the problem. They are more complicated than the alternatives, and therefore understandably advisers and clients probably shy away from them.