Advisers need to reassess their approach to selecting cashflow planning tools, according to consultant Rory Percival in light of new pension transfer analysis rules and Mifid II legislation.
The former FCA technical specialist has produced a new due diligence guide to cashflow planning for advisers as pension freedoms and technological improvements have begun to increase the popularity of the practice.
In the lead up to the introduction of the FCA’s Appropriate Pension Transfer Analysis Percival says advisers should avoid approaching cashflow planning as a one-size-fits-all solution, and break down needs based on different life stages.
Young accumulators, older accumulators in the transition to retirement, those about to retire, and retired clients can be viewed as the defining life stages.
Percival says: “Cashflow planning can be about any form of income and outgoings and does not have to relate to the client’s overall position; it shouldn’t be used dogmatically.
“Advisory firms must have a process in place to identify client segments and the types of services and investments that are appropriate for each client segment.”
When choosing cashflow planning tools, a simple solution that gives the adviser flexibility may be a better long-term choice that a sophisticated offering.
While more complex ones take longer to prepare but can do more difficult tax calculations, Percival warns they also involve more due diligence.
He says: “One other consideration which may work for some firms is to use two tools; a very simple one where simple cashflows are needed and a more complex one where you also have clients where the additional features are valuable.”
Advisers should also be considering alternative ways to achieve a clients’ objectives under the regulator’s new assessment of suitability guidance.
Percival says: “Building this into the cashflow is a much better way of exploring this option than getting a life assurance quote.”
Advisers are also now working under Mifid II rules which say firms must ensure all tools are suitable for clients and their risks actively mitigated.
Regardless of whether an adviser is using stochastic or deterministic modelling, considering the downside risk against the client’s capacity for loss works to test the cashflow plan, determining whether tools of adequate complexity are in use.
Pericaval says: “If potential losses mean that the client’s capacity for loss is breached, then you should consider another solution for the client. If this is not possible then you need to tell the client that their objectives cannot reasonably be met.”
A shortfall between income and expenditure should also be treated differently depending on the tool’s complexity.
Percival says: “Consider if assets are drawn from cash deposits first, and where from once these are depleted. You need to be able to understand this sort of detail in the tool so advisers need appropriate training.”
As well as being “approximately right rather than perfectly wrong,” Percival adds advisers need to use sensible evidence-based assumptions when making calculations, without getting too hung up on being overly precise.
He says: “It is fine to have approximations in terms of the outputs from the tool and you should include a caveat in the cashflow report and your suitability report about the figures being approximations and being heavily influenced by differences between assumptions and reality”.
When following up with suitability reports, Percival says cashflow reports should still be provided separately in most cases.
He says: “Given their importance, you could include the main assumptions [but] suitability reports often focus too much on the investments whereas the focus should be on the plan and how it meets the client’s objectives.”
Differently levels of complexity within tools may also determine whether tax, lifetime allowance, annual allowance and national insurance are included.
Percival says: “Clearly, advisers need to understand the tool and how it works. They should make sure all users are aware of these and have a firm-level process to mitigate these limitations as per Mifid rules.”
Advisers should also confirm tax and national insurance calculations are not incorrect before being entered into a cas-flow plan for recalculation.
Risk profiling tools are still more common amongst advisers than cashflow planning tools according to research from Platforum. Fifteen per cent of advisers do not use cashflow tools, while 39 per cent use them for less than three quarters of their clients in the retirement stage.
Platforum agrees the use of cashflow modelling tools is likely to increase under Mifid II regulations.
Percival’s due diligence consideration’s for selecting a cashflow planning tool
- Deterministic or stochastic
- If stochastic, basis of modelling
- Notional or real
- Assumptions (what is built in and what is adaptable)
- How does the system use assets to provide income and withdrawals? What flexibility is there?
- What it calculates/doesn’t calculate
- Planned updates
- Update process in event of legislative changes
- Input time
- Data protection
- Integrations with other tools
- Trial period