Drawdown Strategies Choosing the Right One for Your Client

Transcription

1 Drawdown Strategies Choosing the Right One for Your Client Peter Carter Product & Marketing Director Retirement Advantage All content in this presentation is the copyright of Retirement Advantage. Although the content is freely available, it is not in the public domain. This presentation may not be reproduced, copied or published in any form, in print or electronically, in whole or in part, or passed on to any third party, without the express written permission of Retirement Advantage.

2 Continuing Professional Development (CPD) What you will learn during this presentation Stochastic modelling as a way of predicting outcomes from drawdown Different ways of organising drawdown portfolios Mitigating risks for drawdown clients The likely outcomes from different strategies Fitting client profiles to those drawdown strategies Selecting the best strategies for different client types 2

3 Drawdown Strategies Conference Introduction Overview of the Market Post Pension Freedoms Current Retirement Landscape Experience Elsewhere Accumulation vs. Decumulation The Outcomes The Strategies The Analysis The Results Summary and Conclusion

4 2013 Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q3 Market Overview Post Pension Freedoms Move from annuity purchase to income drawdown Large number of people cash in completely Average premium size of drawdown has gone down (then up!) and average premium of annuities has gone up! 3,500,000 Drawdown 100,000 3,500,000 Annuity 100,000 3,000,000 90,000 80,000 3,000,000 90,000 80,000 2,500,000 70,000 2,500,000 70,000 2,000,000 60,000 2,000,000 60,000 50,000 50,000 1,500,000 40,000 1,500,000 40,000 1,000,000 30,000 1,000,000 30, ,000 20,000 10, ,000 20,000 10, Source: Association of British Insurers 4

5 Current Retirement Landscape Why is the current generation of retirees doing so well? Previous Retirees Old Age Pension State Earnings Related Pension Scheme Employers Defined Benefit Pension Current Retirees Old Age Pension State 2 nd Pension Employers Defined Benefit Pension Employers Defined Contribution Pension Future Retirees New Basis Old Age Pension Employers Defined Contribution Pension More Guaranteed Less Guaranteed 5

6 Experiences Elsewhere Australia and the United States are the two Anglo-Saxon countries which have had a retirement income market like ours but for much longer 40% of Australians have exhausted their pension fund by age 75 Americans withdraw 8% per annum from their pension funds making them last for 17 years (5 years less than average life expectancy at age 65) In both countries there are moves to increase the use of annuitisation (longevity risk management) Australia recommendation of Financial System Inquiry for Comprehensive Income Products for Retirement (CIPR) United States more freedom to invest in payout annuities via retirement plans 6

7 Non-advised Sales Likely to Exceed 50% by Source: Financial Conduct Authority and Association of British Insurers Projections Making Sense of Retirement Limited 7

8 Retirement is Different to Saving Accumulation Fixed term horizon Converting income to capital Investing for growth Increasing capital Pound cost averaging Decumulation Converting capital to income Unknown time horizon Investing for income Reducing capital Pound cost ravaging Retirement is different to saving for retirement You need a different strategy Just as there are different strategies for saving, there are different ones for retirement We road tested 5 retirement strategies to see how they fared 8

9 Five Retirement Strategies 1. Unit Cancellation Invest pension fund and cancel units to provide income on a regular basis 2. Cash Buffer Investing some future income in cash to reduce sequence risk 3. Live off yield Income provided by the natural yield of the investments 4. Annuitisation Buy an annuity for income requirement 5. Longevity Back Stop Set aside a portion of the fund to buy an annuity at age 85 or 90 to mitigate longevity risk 9

10 The Analysis We Did 10,000 simulations for each strategy using real market data Investment 200,000 in each case Income of 5% taken monthly (unless specified otherwise) Annual management charge of (fund and product) 1.0% per annum Adviser fees of 3.0% initial and 0.5% per annum Asset allocation: 60% equity, 40% bonds 10

11 How We Scored Each Strategy Each strategy was given a score from 1 to 5 in 5 key areas: Fixed Income Longevity of income Combating inflation Access to capital Legacy potential Is the level of income fixed each time it s paid or does it vary from month to month Is the income guaranteed to last a lifetime What potential does the income have to rise to help combat inflation Can the capital easily be accessed once the strategy has started Is there likely to be money left over for beneficiaries 11

12 Unit Cancellation 200,000 invested 10,000 (5%) income taken monthly Years th th th % 50% 25% Probability of Survival Source: E Value and Retirement Advantage 12

13 Unit Cancellation Feature Fixed Income Longevity of Income Combat Inflation Access to Capital Legacy Potential Rank Unit cancellation gives a strong level of fixed income up until the fund is exhausted Fund exhaustion is likely for many retirees unless action is taken to actively manage the income Capital is easily accessible along the way so changes in circumstances can be handled especially in the early years of retirement If income has been taken consistently, the legacy potential at normal life expectancies is likely to be small 13

14 Cash Buffer 200,000 invested 10,000 (5%) income taken monthly. 2 years income in cash Years th th th % 50% 25% Probability of Survival Source: E Value and Retirement Advantage 14

15 Cash Buffer Feature Fixed Income Longevity of Income Combat Inflation Access to Capital Legacy Potential Rank Actually scores less well than straightforward unit cancellation Two reasons: Cash performs very poorly Sequence risk is actually exaggerated as when unit prices are low, 24 months income is bought at the lower reprice Same scores as standard unit cancellation One major advantage is that having 2 years income secured gives adviser more time to take corrective action 15

16 Live Off Yield Probability of Survival 75% 50% 25% 350, , ,457 75% 250, , , ,551 50% 100,000 50,000 98,288 25% - Years Source: E Value and Retirement Advantage 16

17 Living Off Yield 1,600 Probability of Survival 75% 50% 25% 1,400 75% 1,200 1, Annuity 50% % Source: E Value and Retirement Advantage 17

18 Live Off Yield Feature Fixed Income Longevity of Income Combat Inflation Access to Capital Legacy Potential Rank In this scenario, income takes a back seat to access and legacy Initial income is lower than the other scenarios as its determined by the yield of the assets in which the client invests Both income and capital are sustainable throughout life but income is at a lower level than an annuity would be likely to offer Indeed it is only the most optimistic scenarios where income has a chance of beating an annuity after 18 years (75 th percentile) 18

19 Longevity Tail Risk Fund Value 250,000 Probability of Survival 75% 50% 25% 200, ,000 75% 50% 100,000 25% 50,000 - Source: E Value and Retirement Advantage 19

20 Longevity Tail Risk - Income 2,000 1,800 1,600 Probability of Survival 75% 50% 25% 75% 1,400 1,200 1, % Annuity 25% Source: E Value and Retirement Advantage 20

21 Longevity Tail Risk Feature Fixed Income Longevity of Income Combat Inflation Access to Capital Legacy Potential Rank A more complex strategy, but one that makes delivering investment based income easier Income still variable but can be managed using a protected/guaranteed fund Income will last a lifetime, although the amount is not certain Inflation protection during early years is equal to unit cancellation strategy, but in later years is fixed via an annuity During early years, good access to capital and potential for legacy. Once annuity purchased, legacy depends on annuity shape 21

22 Annuitisation - Income 14,000 13,000 Liver Cancer 13,000 12,000 11,000 Heart Attack 11,368 10,000 Healthy 9,500 9,000 8,000 7,000 6,000 Source: Retirement Advantage 22

23 Annuitisation Feature Fixed Income Longevity of Income Combat Inflation Access to Capital Legacy Potential Rank The simplest mechanism for providing income and also the one that provides the greatest level of income in the early years (if it is to be sustainable) Access to capital is poor as capital is exchanged for income Legacy can be improved using guarantee periods (30 years) and money back guarantees Inflation protection is costly however Can play a strong part in association with other strategies, particularly to cover essential expenses 23

24 Summary Strategy Fixed Income Unit Cancellation Cash Buffer Live Off Yield Longevity Tail Risk Annuity Longevity of Income Combat Inflation Access to capital Legacy Potential

25 What is a Sustainable Level of Income? Income 95% certain to last for 25 years (to age 90) Strategy Sustainable income Unit Cancellation 3.31% Cash Buffer 3.31% Live Off Yield 3.82% Longevity Tail Risk 3.75% Annuity 5.19% 25

26 Conclusion There is no silver bullet that indicates a best way of organising a pension fund for decumulation Understanding the client is vital and different client needs suggest different solutions It is clear that some solutions are better at delivering certain outcomes than others (although usually at the expense of one of the others) For certain, lifetime income an annuity is unbeatable, but at the expense of access For legacy/access, living off the yield is best but at the expense of the level of income over a lifetime A flexible balance can be reached with the longevity tail risk strategy For many clients a combination of approaches is likely to give the best solution This highlights the essential need for advice in the decumulation retirement market 26

27 The Retirement Account Flexi-Access Drawdown contract Includes an annuity for life within drawdown rules Investment proposition designed for decumulation Investment proposition monitored and governed by Square Mile Investment Consulting and Research Annuity is underwritten to give best rates for medical conditions Tax advantageous treatment of annuity within drawdown Flexible annuity income 30 year annuity guarantees with commutation on death 27

28 How likely are you to recommend an income drawdown solution (rather than an annuity)? 120% 100% 80% 60% 40% 20% 0% -20% -40% -60% -80% 98% 98% 98% 74% 46% -26% -54% 50, , , ,000 1,000,000 Source: Opinium August

29 How often do you recommend the following in an income drawdown portfolio? 120% 100% 80% 78% 94% 72% 60% 40% 20% 20% 40% 0% -20% -40% -22% -6% -28% -60% -80% -100% Low risk funds Medium risk funds Managed / governed portfolios -80% Protected or guaranteed funds -60% Cash Often Not often Source: Opinium August

30 What proportion of active and passive funds do you typically recommend for drawdown clients? 60% 50% 49% 40% 34% 39% 30% 20% 10% 0% 9% 2% 2% I don t use this 6% 10% 13% 23% 8% 5% 0% 1-25% 26-50% 51-75% Over 75% Active Funds Index Funds Source: Opinium August

31 How often do you use the following methods when deciding on a withdrawal rate in drawdown? 100% 80% 60% 75% 66% 53% 40% 20% 23% 24% 0% -20% -40% -60% -25% -34% -47% -80% -100% -77% -76% Unit Cancellation Cash Buffer Natura Yield Annuitisation Longevty Tail Risk Often Not Often Source: Opinium August

32 How Often Do You Review Client Portfolios? 2 yearly, 3% 3 yearly, 1% 6 months, 14% Annually, 82% Source: Opinium August

33 Continuing Professional Development (CPD) Points covered in this presentation and on which CPD time will be credited Stochastic modelling as a way of predicting outcomes from drawdown Different ways of organising drawdown portfolios Mitigating risks for drawdown clients The likely outcomes from different strategies Fitting client profiles to those drawdown strategies Selecting the best strategies for different client types 33