As drawdown sales rocket and life expectancies grow, how can advisers make sure their charging models stay fair?
How to charge for financial advice has been an issue that has held the spotlight in recent years.
The RDR heralded a new era of transparency in charging and a crackdown on commissions and rebates. But while the years since its introduction have seen many advisers and clients settle into new pricing models they feel comfortable with, be they fixed fees or time-based charges, the majority are still wedded to charges built on a percentage-of-assets basis.
The pension freedoms have thrown up further challenges on post-retirement charging. The 2015 reforms were supposed to give consumers more control over their pension pots and more flexibility in accessing their savings than ever before.
Savers would no longer have to take an annuity and, as a result, the popularity of drawdown plans has soared, particularly among those with smaller pots.
But an explosion in drawdown sales presents a number of issues; these freedoms have arrived at a time when people are living longer than ever before but interest rates are stuck near record lows. A client’s pension pot may now have to last them the course of a 30-year retirement, a period which could include any number of events that eat into assets, from a stockmarket sell-off to a property market crash or pricey care home fees.
Advisers have to grapple with that longevity issue, while at the same time ensuring the vital advice which will help clients in the decumulation phase of their financial journey remains profitable so their own business lasts.
The drawdown dilemma
While many clients have become accustomed to the percentage-based charging model during accumulation, it could be argued that this can become a conflict of interest once they reach later life. After all, an adviser will see the fee they take dwindle if they encourage their clients to spend some of their savings.
This is a particularly acute issue as life expectancies are lengthening and client needs get increasingly complex, leading many planners to look at charging additional fixed fees or using modular packages as service needs stack up.
CWC Research senior partner Clive Waller says: “Charging 1 per cent a year for drawdown for a client with a £500,000 pension pot is £5,000 a year to an IFA. I think that this guaranteed cashflow could easily unconsciously weigh your decision as an adviser as to what you recommend.”
However, Addidi Wealth chief executive Anna Sofat does not feel that percentage charges stand in the way of recommending suitably aggressive withdrawal rates in drawdown.
She says: “We are good at dealing with conflict. We want people to spend their money so we have focused on making sure our clients enjoy it. We establish a sustainable drawdown strategy and we charge 1 per cent subject to a minimum.”
She argues that this approach to charging can often be cheaper than a fixed fee, particularly for less wealthy clients. But Sofat says there is a danger that a focus on just bringing costs down will lead to less wealthy clients being shut out of advice.
“We do have a habit of bringing everything back to zero sum,” she says. “People with less wealth are being encouraged to go down the drawdown route and it’s not right if, say, we won’t help them or that it’s too costly to service them. Maybe fees have to go up, but does that matter if the client is getting value for money?”
This addresses one of the key problems with mass drawdown, which is that suddenly a route has been opened to decumulation to those who have not previously been able to access it because they were perceived to not have enough wealth for the strategy to be viable. While this freedom of choice is doubtless a positive development, it brings with it the problem of how to withdraw from a smaller pot in a sustainable way.
The popularity of drawdown has certainly been driven in part by a record long bull run in stockmarkets. Clients accessing their cash in recent years would have enjoyed a rare situation whereby stockmarket gains will have replenished their pots as they have withdrawn money from them. It has made the traditional drawdown rule of thumb of 4 per cent – the proportion of assets one can sustainably withdraw each year – an easier feat to achieve.
But this will not always be the case. That much is clear enough from recent weeks on the stockmarket, where a sell-off has shaved some 500 points off of the FTSE in little over a month. If the value of investments plunges at the time that a client needs to access their cash, that creates a serious problem.
Investment Quorum chief executive Petronella West says: “The main issue with drawdown is pound-cost ravaging. This is where you have a finite amount of money, you are taking money from a decreasing pot and then it is getting drained at a time like now when the stockmarket falls.”
This is one reason why Waller has an issue with drawdown in general. “People taking drawdown when they have pots of £100,000 or less scares the life out of me, but the industry has an interest in keeping people invested,” he says.
Petronella West, chief executive, Investment Quorum
I use the analogy of a bathtub when I think about drawdown. It is being filled from the tank while being drained from the plug as you take money out. The priority is that the bath must not run dry. In this analogy, the IFA is the plumber, keeping the system running with regular check-ups and called in to manage emergencies. An adviser needs to be paid for those financial reviews and for planning around any unexpected issues, just as a plumber needs to be paid to keep the system running.
A fee rethink?
Waller does not believe advisers should get an annual fee for recommending drawdown, but should only be compensated for their initial set-up of the product and the financial planning that involves.
He adds: “A lawyer or accountant doesn’t get a fee for life when they do their job. People take a defined benefit pension or annuity and get no further financial planning and don’t pay 1 per cent a year for that, so I don’t think it’s possible to justify that annual fee for drawdown.”
But many advisers disagree with this outlook. That retirements are longer than ever before means they require careful ongoing planning and management, some argue, suiting the percentage model of charging.
West says: “Drawdown is seen as an opportunity to grab assets and take a fee but there is a lot of planning that goes into it by the adviser.”
Sofat adds: “This is the point when advice is most needed and when clients are most sensitive. What’s the alternative [to advice]? They either try to muddle through themselves or the industry makes products that don’t need managing.”
There have been increasing calls in recent years for providers to do more to create solutions which suit a modern-day retirement.
Pension freedoms are relatively new so it could be that the industry has not had long to build solutions suited to enabling this new type of decumulation in a cost-effective way.
But others point out that DB pension schemes and annuities have dealt with exactly the same issue – providing an income for life without the need for regular financial reviews – for decades, so moving this to a drawdown model should not be beyond the realms of possibility.
Sofat says: “[These product providers] have done all of the work about sustainable rates of withdrawal already, but everyone keeps all of this information to themselves. I think sharing information across the industry would help to drive costs down.”
She thinks sharing information – between advisers, providers and even different countries – is crucial to determining which are the best and worst solutions.
Patrick Connolly, financial planner, Chase de Vere
Most of our clients are paying a percentage fee based on the assets we manage for them. But as client circumstances change, we will review our charges to make sure they continue to offer fair value. Later life planning is an area where specialist advice is required and we may be working with the client as well as their family, power of attorney or other advisers. Any charges should reflect the advice given and preferences of the client or those representing them.
A helping hand from above
There is a feeling among advisers that the regulator could do more to encourage better practice in this space too. While there has been some focus on raising the standard around DB pension transfers, some advisers suggest exams could be introduced around drawdown to ensure advisers are fully qualified to deal with this most crucial stage of financial planning and that they are having robust conversations with clients.
But West says the onus is on advisers to be proactive. They must properly articulate the value they are providing to clients in the decumulation phase so the consumer understands that advice is worth paying for at this time of life and the way they charge fees represents good value.
She says: “I think consumers understand that advice is a professional service and that it costs money but they don’t always understand the benefit that it brings.”
She adds: “Drawdown is a complex product and advisers need to know how to communicate the value they can bring in navigating it, because if a client believes they are getting value for money, the cost should be irrelevant.”
Sofat agrees: “We need to move away from just talking about fees or we will end up doing more damage. We don’t want consumers to just think that advice is too costly so they don’t bother taking any.”
Plan Money director Pete Chadborn typically uses a fixed-fee charging model but says that in the case of decumulation, it may not always be in the client’s best interest and that percentage-based fees can be more appropriate.
He says: “At some stage, depending on the prevailing drawdown value, the fixed fee becomes unviable from the client’s point of view.”
This presents a problem from both sides: from the client’s perspective, they may be inclined to ditch financial advice which is becoming increasingly costly as they drawdown on their savings, and from the adviser’s perspective, they may be less inclined to serve a client whose wealth – and therefore means of payment – is dwindling.
Chadborn adds: “I think the best solution is to relate the cost to the service on a case-by-case basis and have an open conversation periodically with clients to ensure both are deriving appropriate value.”
Delta Financial Management director Jarrod Ellis adds: “If a client is genuinely running down their funds because they do not have sufficient income to maintain their value, then a fixed fee will slowly become a greater proportion of their investment. This is obviously detrimental to the client, so a percentage-based charge is fairer.
“But, at the same time, that model does mean the adviser’s fee is falling. The adviser has to make a call as to how they address that.”
He adds: “Clients generally like a percentage-based fee model in so far as it is known and if their funds increase, the adviser’s fee grows, but if their funds fall, so does the adviser’s fee.”
Do not ignore the risks of drawdown failure
Giving advice that will have a major impact on the rest of someone’s life is a considerable responsibility. It is one thing advising a 50-year-old who is investing an unexpected inheritance, but it is quite another making recommendations to a 65-year-old retiring with a portfolio of £300,000. The advice you give in the latter scenario will dictate the quality of the individual’s entire retirement. In times gone by, an annuity was always the answer.
At current rates, an annuity would provide that retiree with a £300,000 pot an income of just over £15,000 a year for a male single life, or £12,500 for a joint life product, reducing by one third on a first death basis.
Following pension freedoms, the 4 per cent rule is often cited in drawdown as a sustainable level of withdrawal for clients looking to determine a strategy for their money. But on the same pension pot, this gives an income of £12,000 a year.
There is a major difference too: the annuity guarantees a lifetime income.
The drawdown solution provides a death benefit but only until the money runs out.
Annuities are a simple solution, which will do the job they are asked to. Drawdown, on the other hand, allows one to remain invested, potentially producing an increasing income and residual benefit on death. But a crash in the early years can prove fatal, as can simply living too long.
Fans of drawdown point out that there is a 90 per cent chance that clients will never run out of money – shame about the other 10 per cent then.
It should always be remembered that asset managers, platforms and advisers have a significant financial interest in the client staying invested. All must make sure that the advice is absolutely suitable for the client.
Clive Waller is senior partner at CWC Research