Flexing drawdown for better client outcomes
This article has been written by the technical department at Standard Life
Flexibility to vary income to adapt to changing needs is perhaps the key appeal of income drawdown. So the drawdown changes announced in March's Budget create a catalyst for advice to help drawdown clients achieve better outcomes in retirement.
Advice is the key to good client outcomes
Standard Life's research shows that, particularly for wealthier clients, income needs are unlikely to match the conventional pension income shapes produced by annuities or defined benefit schemes.
SMILE!
•For many, we've identified a 'retirement income smile' pattern. This is driven by higher demand for income early in retirement when clients are still active. Income needs drop off with age, then pick up again as personal assistance and long term care needs develop.
•Others simply want a relatively modest, sustainable income – but with scope to turn it up if their circumstances change.
•Some wealthy clients' main need is to draw as much income as early as possible to gift to loved ones, via trusts or pension plans as well as directly, as part of a wealth transfer strategy.
Income drawdown is well suited to meet all these diverse client needs and aims. And the higher the income limit available, the more room there is to manoeuvre. Which is why the Budget announcement was so welcome.
But it's not about always taking the maximum allowed, it's about having the flexibility to take more income when it's needed and cut it back again when it isn't.
This is where advice is key. Drawdown isn't a 'self-service' option. It's complicated. There has never been a better time for advisers to demonstrate their true worth by helping drawdown clients do the right thing to exploit this flexibility to attain their financial goals.
Where did it all go wrong?
Drawdown users, and their advisers, have had a rough ride in the last few years. Markets have been difficult. But much of the pain has been imposed by the drawdown regime itself:
•The linking of drawdown rates to gilt yields means that plunging yields fuelled by QE have had a disproportionate impact on income limits.
•And the 20% limit cut, and new GAD tables, in 2011 simply compounded the problems.
A typical example illustrates this:
•A 60 year old man starting drawdown with a £100,000 pot in August 2007 (when gilt yields were 5.25%) would have had an income limit of £8,280 a year.
•At his 5-yearly review in August 2012, even if he'd maintained his £100,000 pot, this client's new income limit would only have been £5,300 (56% lower than the old limit)! This is partly owing to the 20% headline limit cut – but primarily because, by then, the gilt yield had dropped to 2%.
It's a case of the tail wagging the dog. Logically, with the same pot having to last him 5 years less, this gent's allowable income should have gone up!
Light at the end of the tunnel – an advice opportunity
Thankfully core elements are coalescing to create light at the end of the tunnel.
•Most importantly, gilt yields appear to have at last bottomed out (IG: but remember, this may not be the case and they could fall further).
•Markets remain volatile, but they're well up on the lows of 2009 that saw the FTSE 100 drop to almost 3,500. And the increasing availability of sophisticated, risk-based investment solutions makes it easier to reduce the volatility that can be so damaging in a decumulation environment.
•These factors, combined with the move back to 120%, should get income limits back to more realistic levels from the start of drawdown users' next income year after 25 March 2013.
Here is an example:
Edith started pension drawdown on 1 August 2012. She was 60, her drawdown pot was worth £150k and the GAD drawdown yield was 2.0% - giving an income limit of £6,450.
If no action is taken, this will simply increase by 20% to £7,740 from 1 August 2013.
But what if Edith triggers an earlier review by paying more money into her drawdown pot on 30 March? Changes since August could really boost her income limit:
•Unisex rates: Edith now benefits from 'unisex' (male) drawdown rates, following the implementation of the EU Gender Directive into UK law in December 2012.
•Rising yields: The GAD drawdown yield has gone up from 2.0% to 2.75% since August 2012.
•Rising markets: The FTSE has grown by about 25% over the same period. Suppose Edith's drawdown fund has done the same. So, even after taking her maximum £6,450 income, it's now worth about £180k.
•Getting older: And Edith has had a birthday, so is now 61.
Edith's new 100% income limit is £9,360 – allowing her to take an extra £2,910 from her drawdown pot before her new income year starts on 1 August.
This will increase by 20% to £11,232 on 1 August - over 45% more than if no action was taken (and over 74% higher than her August 2012 limit).
And the Government's kick-start of an early review to get GAD drawdown rates themselves back to reality mean there's more good news in the pipeline.
For example, improving market conditions mean advisers can potentially help boost clients' income limits sooner than the start of their next income year. This can also turbocharge the effect of the 20% hike when it comes. An early income review can be triggered simply by phasing more funds into an existing drawdown pot. Or by requesting an ad hoc limits review from the start of the new drawdown year.
This sort of flexibility supports holistic advice strategies that help put the client's needs first. Which is what drawdown is all about. But good professional advice is the key that can unlock it – creating the fundamental building blocks for the successful use of income drawdown as part of an efficient, flexible, but sustainable wealth decumulation strategy.
If you are a client of Green Financial - or not - and would like an income drawdown review, please contact me
