A question of guarantees
Should advisers be giving greater consideration to the use of guaranteed products when making retirement planning decisions?
The key challenge when making retirement planning decisions is quite simply making sure the client gets the right income for them. Taking a dogmatic position for or against a particular product should not be allowed to get in the way of that central aim.
Guaranteed pension and bond products do not suit everyone. Those who want the maximum possible income at retirement should probably avoid them while those who have a high tolerance for risk should also steer clear. However, for most other clients, guaranteed products have a major role to play in helping achieve retirement planning aims.
The retirement planning market has been transformed in the past five years and will continue to evolve as legislation scrapping compulsory annuitisation at age 75 and default retirement ages takes effect. Legislation aside, the market has to change. The switch to defined-contribution pension schemes means there will be more people with bigger pension ’The combination of legislative and societal change makes a compelling case for more innovation and flexibility in the market’ funds seeking greater choice on how they use their retirement savings to secure retirement income.
The combination of legislative and societal change makes a compelling case for increased innovation and flexibility in the UK retirement market. The traditional annuity and drawdown options remain valid but other solutions should be considered.
There is always a case for unit-linked guarantees on pensions and bonds for more cautious clients as without guarantees, customers are exposed directly to downturns in the stockmarket. When markets recover, it makes sense to lock in gains along the way, particularly for clients who are close to retiring and cannot afford sudden losses.
Someone investing £500 a month for 25 years can expect a pension pot of £407,000 but if they suffered a 20 per cent market fall five years before retirement would need to increase contributions to £1,531 a month. If the same 20 per cent drop happened in the first five years of saving, contributions must rise by only £55.51 a month.
Guaranteed products ensure investors always get a minimum amount back while having the potential to lock-in returns on their investments. They can be used in investments such as bonds or to save for retirement and also once clients have retired and want an income from their money.
Advisers know they have to look at all potential solutions to ensure that clients receive the best possible retirement income. Guaranteed products are firmly established in the mainstream of retirement planning and ignoring them should not be a consideration.
The arguments for guaranteed products are compelling. There is no doubt that a product or fund which offers some of the performance of the stockmarket without the downside risk is attractive to clients and advisers alike.
However, guaranteed products do not have the greatest history. With-profits offered guarantees through reversionary bonuses but I am not convinced they have worked for the majority of investors for about 10 years. With-profits used to work well until insurers started to chase more clients by offering bigger bonuses, bigger guarantees and higher equity content in their funds. It is telling the numbers of with-profits providers who now benchmark their performance against cash rather than managed funds as they used to even when equity contents have been as high as 90 per cent in some cases.
Looking at other examples, ’We have seen more than one high-profile guaranteed pro-vider withdraw from the market and this does not inspire confidence’those of a certain age will remember in the late nineties there were a variety of funds with so-called ratchet systems periodically locking in growth to protect the downside. Unfortunately, many performed as the system sounded, failing to grow when the market did and consequently locking in very little. More recently, we have seen more than one high-profile guaranteed product provider withdraw from the market, short order product revamps and, in some cases, a toning down of guarantees. This does not inspire confidence. Furthermore, of those providers still active, there is a high price to pay for the guarantees, typically 1 per cent on top of other charges and any commission/adviser remuneration.
With-profits aside, there is little market data to help advisers make informed decisions on these products. In part, you have to question whether any of them do or have worked if they had, we would have marketing departments shouting how wonderful they are. It might simply be that they have not been around long enough, but this lack of (and expensive) choice, combined with little evidence of a successful track record makes it hard to find these products appealing. Either way, I do not have confidence that clients will not simply experience mediocrity for a high price.
Perhaps a better solution is for clients to contrive their own more flexible “guaranteed” structure keep 80 per cent of their money in cash the guaranteed bit and invest the balance. This avoids the high costs and provides far greater investment choice. When and if the market produces the right products, I will be happy to look again.