Keeping things simple

Bernard Footitt looks at how increasing complexity in the retirement market affects how advisers deal with their clients

At the time, the Personal Investment Authority's Regulatory Update 55 (RU55) - August 1998 - seemed to be complex guidance for the advice process in the at-retirement market. On reflection today, it is a very basic guide to the 'scope of financial advice'. In the intervening years, further guidance on reports and suitability letters as well as the whole treating customers fairly initiative has come out to supplement RU55 since it first saw the light of day. In addition, the simplification of pensions taxation since A-Day and new ways of taking one's retirement income have driven the advice model for at-retirees to new levels of complexity.

With the arrival of the baby boomers at the gateway to retirement, their use of pension and non-pension sources of income to sustain themselves throughout their ever expanding life-span has also affected the advice model. It is estimated that this group has an investment portfolio that they could divest to supplement 'pension' income that includes:

- Cash on deposit;

- Gilts and National Savings;

- TESSA and successor products;

- PEPs and ISAs;

- Collectives and life assurance investments;

- Non-wrapped savings and investments;

- Investment property.

The 55-64 age group hold £420bn in cash and liquid assets¹ that includes cash, gilts, bonds, equities, endowments, unit trusts, ISAs and National Savings². People retiring today have dramatically greater life expectancy than ever before. Just using the Office for National Statistics conservative Interim Life Tables, the following comparison of expectation of life based on data for the years 1980-1982 with 2004-2006 reveals (see table below):

Putting the earlier quantified longevity risk together with the liquidity issue of 'how much to withdraw' should be not so much feared, but rather as something to be controlled as far as possible. No-one can estimate how long they will live, and the market itself brings great confusion in the area deciding on a sensible level of income withdrawal from capital.

Withdrawal rates

Conventional drawdown directly from a pension fund allows as much as 9% of the fund value to be withdrawn at July's GAD reference rate (5%)³. Newer drawdown products with guaranteed income/withdrawal allow around 5% of the fund value to be withdrawn as a guarantee. The staple product - a conventional lifetime annuity - currently offers around a 7.7% yield⁴. All of these refer to the benchmark 65-year-old male, and are a recipe for potential confusion on the liquidity issue alone.

Add to this the availability of a new generation of fixed income arrangements that do not provide true pension income, such as offshore investment bonds offering say 5% capital withdrawal for life, with this income taxed on a purchased life annuity basis, the whole at-retirement advice model becomes exceptionally complex.

A recently published piece of research⁵ had the following responses, in summary from financial advisers, to just three of the questions posed (see table on left).

The RU55 'scope of financial advice' still seems a pretty sound advice model that says: "The investor may expect advice which includes the following:

- An analysis of the investor's retirement needs - taking into account the investor's financial circumstances and all financial arrangements including any accumulated pension fund, the investor's objectives and attitude to risk;

- An analysis of the financial options and solutions available - including a comparison of the relative advantages and disadvantages of the pension fund withdrawal (PFW) plan and immediate annuity purchase, (...). The analysis should also take account of the investor's other means and resources for providing income;

- Recommendations and the reasons why these recommendations are considered suitable - covering how the recommendations would meet the investor's needs and objectives, and explaining the product detail, the choice of investment fund, and the risk factors, such as critical yield and the cost of PFW plan flexibility;

- Ongoing advice on the investor's financial arrangements - the investor may expect to receive regular ongoing advice including information on performance against the objectives which the investor has set."

Further on in RU55, there is a sub-paragraph: "Investor's complete investment portfolio

- Advisers should also be aware of the wider investment issues. For example, as an alternative to taking income from the drawdown, an investor could provide income from periodic encashment of direct equity holdings or other investments."

I find it fascinating that guidance given 10 years ago remains so strikingly relevant for today's advice giving model.

¹ Source: Bacon and Woodrow, Government Actuary's Department and Prudential analysis 2007

² Includes: cash, gilts, bonds, equities, endowments, unit trusts, ISAs and National Savings products

³ Government Actuary's Department Appendix A: Table 1 - MEN

⁴ Source: Canada Life as at 30 June 2008

⁵ Source: Retirement Solutions (New Model Research Issue 2)