Ever since the pension freedoms were announced I have been asking the following question: what does drawdown for the mass-market look like? The answer to this question lies in tackling two important issues: who is drawdown most suitable for and which products are most suitable?
Traditionally, drawdown has been regarded as an option only suitable for higher-net-worth clients but people like me have long argued it should not be elitist. In the right circumstances it may be appropriate for those with more modest pension pots to invest. The issue is not so much wealth but suitability, but this is an advice-heavy exercise.
The question “annuity or drawdown?” can be one of the most difficult for advisers and clients. I can recall situations where people who purchased annuities would have been better off in drawdown and some who invested in drawdown probably should have purchased an annuity. The right answer is only evident after the passage of time.
One of the reasons why the decision is so complex is that it is often presented as a black and white choice. In my experience, some of the best outcomes have been achieved by a combination of both. Arguably, however, this can take twice as much advice time as a single option solution. See what I mean about advice-heavy?
When it comes to which products are most suitable there are generally only two things that matter: investment choice and charges.
The fund choice and the amount of risk the drawdown plan is exposed to are critical. If returns are too low the drawdown will not provide the same income that could have been purchased from an annuity. If too much risk is taken there is an increased danger of running out of income in the future.
I have always thought one of the difficulties with drawdown is that a higher rate of return is required at older ages in order to maintain the annuity purchasing power. The reason for this is the effect of mortality drag, which can be explained as an invisible force that acts to boost annuity payments.
There is probably no disagreement among advisers that drawdown is better with a bespoke investment strategy rather than a one-size-fits-all approach. The problem is the mass market does not have big enough funds to justify bespoke solutions.
Part of the answer to the mass-market drawdown question could be the new hybrid or combination solutions being launched. These offer both annuity and drawdown-style income in one single plan with one monthly payment. Not only do they allow people to move from drawdown to annuities very easily, they also make the administration extremely easy because there is one combined payment net of tax.
There will be an opposing school of thought that if a combination of annuity and drawdown is needed it can be done better by arranging two separate policies. It is probably a question of scale. The bigger pots will benefit from bespoke advice and best of breed plans but the mass market needs a solution that is suitable for purpose and cost efficient.
Billy Burrows is director of Retirement Intelligence