Expert: Richard Parkin, Founder, Richard Parkin Consulting
Headlines:
- Market falls are proving difficult to manage, particularly with more cautious investors
- Cost of living increases haven’t yet become an issue for most retirement advice clients
- Significant increases in annuity rates mean guaranteed income should be considered for at least part of a client’s income
- Drawdown has likely served most clients well over the past decade, but demonstrating suitability may be more challenging in the future
Context:
A change of speaker meant this round table didn’t follow the original agenda precisely but we did look at whether we are facing a perfect storm for income drawdown coming from market falls, rising interest rates, a higher cost of living and increased regulation. We considered how each of these factors was affecting clients and whether they were leading to changes to the retirement advice firms were giving.
Communicating on market falls
Market falls are proving difficult to manage, particularly with more cautious investors. Clients investing in equities are generally used to volatility, but the sharp rise in interest rates has meant that cautious investors have actually been the worse hit over the past year. Indeed, looking at many risk-rated fund ranges, the lowest risk funds have tended to underperform the higher risk funds due to their greater weighting to fixed income. Given fixed income’s traditional positioning as a counterbalance to equity volatility, explaining these moves to clients is proving challenging.
It was noted that the pandemic-related market gyrations of 2020 have not helped in positioning market volatility with clients. While we saw sharp falls in equity markets, these generally bounced back quickly perhaps setting client expectations that market setbacks are quickly reversed.
The consensus was that we are unlikely to see a quick bounce back from the current position. In fact, we may not see a bounce back for some clients at all. If we are back in a time of more “normal” interest rates, fixed income markets are unlikely to recoup the losses they’ve made over the past 12 months any time soon.
Cost of living
Cost of living increases haven’t yet become an issue for most retirement advice clients. While we are becoming used to seeing double-digit inflation rates, our audience said they have yet to see this manifest itself in terms of increased income demands from advised clients.
Most agreed that advised clients are perhaps less affected by cost-of-living increases since they have higher discretionary spending, which can be adjusted. Nonetheless, clients do not seem wholly immune and will be having to make spending adjustments. Some clients reported having recently discovered the joys of German supermarket chains.
It was also noted that increased expenses don’t necessarily translate to an immediate demand for higher drawdown income. It may be 12 to 18 months before clients recognise that they are consuming cash more quickly than planned and so may need to consider adjusting drawdown plans accordingly.
The case for guaranteed income
Significant increases in annuity rates mean guaranteed income should be considered for at least part of a client’s income.
Annuities have been easy to discount over the past decade, as a result of perceived inflexibility and miserable rates due to low fixed-income yields. The sharp increase in rates since last year, and the sudden spike as a result of the mini-budget, have made annuity rates increasingly attractive. At the time of the roundtable, a level annuity rate for a healthy 65-year-old was over 7%. While rates will have fallen back a little since, annuities are once again worthy of consideration.
Our audience have responded to this in varying degrees. One firm now effectively uses the annuity as the starting position for client conversations, and looks to see if there is any justification for moving away from that. Others are more circumspect and are looking to annuities to provide some underpin of income, if they use them at all.
Clients remain cautious of dying early in the contract but, at these rates, a ten-year guarantee means that a significant part of the purchase cost would be recouped on early death.
Committing completely to an annuity at age 65, when a client is still in good health may not be suitable for all, but it may make sense to at least partially annuitize. Higher interest rates also increase the feasibility of using deferred later-life annuities to manage the risk of living too long. However, these contracts are still not widely available in the UK market.
Regulatory attitudes
Drawdown has likely served most clients well over the past decade, but demonstrating suitability may be more challenging in the future.
The Consumer Duty is likely to shine a light on retirement income advice and it was recently reported that the FCA is gathering evidence for a thematic review of this advice. The Suitability 2 review that was twice postponed and then indefinitely shelved during the pandemic seems set to return.
Most felt that drawdown clients will generally have done well over recent years and so, with annuity rates having been so low, the suitability of drawdown advice should be easy to demonstrate. With markets looking more fragile and annuity rates more attractive, it may be a lot harder to argue that the flexibility of drawdown merits the additional risk going forwards.
There are some specific areas where we may see regulatory spread across the work done on defined benefit pensions. These include demonstrating that the use of individual pension contracts for transfers is better than using a client’s workplace scheme or whether “complex and costly” investment solutions are appropriate for clients who don’t have a lot of investment experience.
We may also see the regulator considering the way advisers think about client objectives, particularly in relation to minimum acceptable income levels.
Key takeaways:
- Since the global financial crisis, we have arguably enjoyed market conditions that have worked well for drawdown clients
- Our audience seemed confident that drawdown remains the right choice for most of their clients but demonstrating this may become more challenging
- There is no doubt that, as annual reviews are conducted, at least some clients will need to revisit their objectives
- With annuities finally looking viable again it seems an advice approach that combines investments alongside guaranteed income is going to become much more common
