I recently chaired the annual Henry Stewart conference on Sipps and retirement options. Various excellent speakers expressed concerns about aspects of the Government’s recent legislative changes to the annuity and drawdown regimes and the related FSA activity, most notably the recently announced review of the quality of drawdown advice.
Certainly, there appears to be a case for arguing the drawdown changes were introduced far too quickly. It took less than nine months for the changes to move from proposal through consultation to legislation and enactment. Although the concept of drawdown was already familiar, the flexible drawdown regime was completely new – and a surprise for many.
Concerns have been raised about the new 100 per cent limit under capped drawdown. In September, Andy Bell of A J Bell wrote to Mark Hoban and gave an example of an individual who had entered drawdown in October 2006, had taken maximum income and was due a review in October 2011. Using the new rules, the maximum income reduced by over 20 per cent. This figure increased to over 30 per cent if allowance was made for depressed market conditions.
Bell also questioned the use of GAD limits linked to gilt yields now that there is no requirement to annuitise. He suggested three options:
- Remove the link between investment yields and maximum income and instead base the maximum income on a single percentage factor based on age and sex which would be applied to the fund value. In my submission to the Treasury during the consultation period, I suggested the maximum should simply be the reciprocal of the number of years the individual has until he or she reaches age 90, with a fixed factor of one-tenth at ages above 80. This would be much easier to understand than the current method and provides protection against the fund being depleted prematurely.
- Replace the gilt-based maximum factors with blended gilt and equity factors.
- Re-instate the 120 per cent of GAD basis that applied under the old regime.
Unsurprisingly, Bell’s proposals were rejected by the Treasury. They were not persuaded by what they saw as the influence of temporary investment conditions rather than a calculation basis and they emphasised that the lower limit had been introduced in response to concerns over the heightened risk of running out of funds when drawdown was extended beyond age 75.
However, research by the Pensions Policy Institute, published earlier this year, showed that while there was a 36 per cent chance of the fund running out before reaching average life expectancy for a typical high earner drawing maximum income, there was also a 33 per cent chance of doubling the fund in nominal terms by the same age. This debate will continue to rage.
I have always held the view that for the right client and with the appropriate investment strategy, drawdown can be beneficial. I estimate that around 300,000 people currently use drawdown and it will be interesting to see the results of the FSA review of advice. My worry is that often the investment strategies are based on conventional balanced management when there are strong arguments for a much more liability-driven approach using stochastic modelling.
The other major change this year was the introduction of flexible drawdown. There has been little demand for this product. This is, first, because of the reluctance of many of the bigger providers to offer this option and, second, because of the new rules which mean contributions must have ceased prior to the tax year in which the minimum income requirement is satisfied.
It is too early to judge whether the Treasury’s original estimate of 8,000 users of flexible drawdown a year is accurate. However, the PPI estimated that in 2010 there were 200,000 individuals who could meet the MIR and had excess DC savings that could be utilised for flexible drawdown. I expect to see a surge in interest in 2012.
Of course, the reforms extended beyond drawdown and have also had an impact on the annuity market. There has been a lot of activity in the fixed-term annuity market despite the potential GAD limitations on income levels and the drawback of the options available at vesting being determined on a single day. The supply of variable annuities remains limited, with only a handful of providers, and the same is true of flexible annuities. Understandably, some of the more complex products are viewed with suspicion by advisers.
For the last 15 years, drawdown has had critics and some of the criticism is justified because the quality of advice has varied enormously. Regulatory constraints have also not helped. Hopefully, the coalition will be prepared to look at the legislative framework again once there is more evidence to support the case for a simpler regime.
In the meantime, the Government could do worse than examine the failure of the marketplace in delivering anything remotely close to optimal solutions for the mass market. Alan Higham of Retirement Angels suggested recently that billions of pounds are being lost at retirement through inefficiencies, lack of understanding and – crucially – lack of advice.
Perhaps rather than focusing on advice inadequacies, the Government would be better served by looking at how to facilitate an environment where all retirees have the chance of achieving something close to an optimal retirement solution.
John Moret is principal of MoretoSipps