Almost everything you read around the new rules for retirement income planning talks of the inevitable expansion of a blended approach to investing.
This, so the logic goes, is the response to managing the four key conflicting pressures at play for those looking to plan for their retirement: longevity, inflation, lack of flexibility and volatility. I would add a couple more to this list, namely, leaving a legacy and minimising taxation.
Traditionally, the answers to the management of these pressures have been in the shape of “some form of annuity” and “some form of drawdown”. Even before the latest changes to the rules on how one can draw benefits in retirement, providers had evolved the basic lifetime annuity to provide a return of some capital after a specified term (the fixed-term annuity) and even a return on death in an attempt to counter the “lack of flexibility” and “leaving a legacy” pressures.
This trend of development is continuing with annuity providers now looking to defend their eroded market and asset managers looking to develop products suitable for funds in drawdown. Elements of “guarantee” and “underpinning” are emerging to respond to the volatility risk while remaining effective in relation to inflation protection and flexibility.
At some point one can see a completely converged product set coming to the fore. And as one does when managing pre-retirement funds it will, for most, be appropriate to design a retirement income strategy that has more than one component to deal with the expected different phases of retirement and/or the different expenditure needs. It is thought most individuals would relate strongly to the logic underpinning such an approach.
At the simplest level, known near-term fixed expenses will be best funded by an investment carrying low risk and high guarantees. This is likely to be funded by cash or something close to it. In relation to known, fixed, continuing expenditure likely to be required throughout life at a minimum level, it may be that some form of annuity is most appropriate.
Meanwhile, most would agree discretionary expenditure or longer-term needs would be better served by an investment carrying a little more risk and a chance of greater return. Here, some form of equity-based investment would seem most appropriate. Some have been talking positively about multi-asset solutions, particularly funds producing clearly identified natural income as part of their mandate.
Expected future fixed costs (for example, for care) could be funded by some form of deferred annuity or longevity insurance. There have already been some developments in this area. Some will inevitably offer a return on death before the income starts and/or the ability to “change one’s mind” and cash out.
Of course, building these options will all carry a price.
As an alternative to pre-purchasing a deferred, future income stream some may just decide to invest for the longer term in some kind of balanced fund with an equity component (possibly some form of target-dated fund), with the proceeds used to buy an annuity later if appropriate.
This would be very much aligned with the sentiment “75 is the new 65”: a recognition annuities are far from defunct, just better value in current conditions at older ages.
As I have mentioned before, life is nothing if not inherently uncertain, so a degree of flexibility to cope with future changes and needs is likely to be high on the agenda. However, the greater the required flexibility or guarantees the higher the cost. And the longer you can exploit your human capital (your ability to earn) the greater risk and, therefore, greater return you can look to secure on your financial capital.
The above has concentrated on the investment of pension funds but for most clients their pension fund will not be their only asset. The majority will have also have access to a mixture of Isas, unwrapped collectives, insurance-based products, VCTs and EISs, cash and property, to name a few. All of these must be taken into account in determining the retirement income strategy, especially to manage tax risk and provide for the leaving of a legacy.
There is also the important matter of the contribution human capital will make. The longer one can keep working, the greater the amount of risk they can take with their financial assets. I will be looking at these aspects of retirement income planning in following articles.
The one thing that is absolutely obvious is that this is not easy and advice will be essential throughout the retirement journey.
Tony Wickenden is joint managing director at Technical Connection