With Office for National Statistics data indicating more than half of personal pension wealth is owned by those over 50, the asset management sector has no choice but to respond to a steady wave of pension pots flowing from the accumulation phase into decumulation.
Next to Brexit, the regulator now considers changing demographic patterns its biggest issue, with a major shift of assets towards ‘post-retirement’ products imminent.
Before the Pensions Freedom Act in April 2015, decumulation was relatively easy to navigate.
At the point of retirement, many clients moved to annuities, which tackled two key risks head on: first, a regular stream of income, irrespective of market conditions, shielded investors from sequencing risk and, second, the lifetime guarantee effectively removed longevity risk from their portfolios.
This worked well up until annuity rates started to decline and some investors needed to look for alternatives.
Pension freedom unlocked the gates to a whole range of post-retirement options with the same investors now free to choose what they want to do with their retirement savings.
We know from experience, however, that any new freedom is followed closely by new responsibilities – with accountability not that far behind.
That accountability might now fall on the shoulders of advisers. With annuities no longer the only game in town, advisers need to guide investors not just up to but through retirement as well.
The reality is that investors now need to be prepared for both accumulation and decumulation. The accumulation stage is often characterised by regular contributions and no withdrawals – an ideal set up for growing investment capital and distinguished by some advisers as their ‘centralised investment proposition’.
The decumulation stage turns that whole scenario on its head, characterised instead by no further contributions and regular withdrawals and potentially requiring a distinct ‘centralised retirement proposition’.
Entering retirement means: your contributions stop, introducing ‘longevity risk’, since without regular top-ups you may live longer than your investment pot allows; and your withdrawals begin, introducing ‘sequencing risk’ as you might become a forced seller in down markets, materially affecting your chances of recovery.
Faced with completely new circumstances in decumulation, mitigating these two new risks becomes an integral part of delivering appropriate outcomes to clients.
The idea of a ‘distinct’ proposition might become the name of the game for the regulator. Certainly, the PROD Sourcebook lays potential requirements to meet the needs of the identifiable target market and deliver appropriate outcomes to clients.
To help advisers navigate that distinct world of decumulation, here are our five ‘top tips’ for those with clients in retirement:
Make sure your portfolio is well diversified
Reaching out to unsustainable levels of portfolio yields at the expense of efficient diversification might be a dangerous strategy that could affect the longevity of the investment pot and increase the risk of financial ruin.
As clients’ risk appetite evolves as they reach retirement, the decumulation proposition needs to reflect that. The suitability requirement hardly stops with the last salary payment and remains fundamental to any recommendation.
One way an adviser may wish to address it is by using risk-targeted propositions that give advisers peace of mind they will not drift across risk profiles over time.
Identify the ways to mitigate sequencing risk
New risks require new solutions and decumulation risks are no different. Propositions that generate an attractive level of natural income or integrate cashflow management into their investment process might help you meet these income requirements, even in volatile markets.
Be ready to question myths of income investing
It is time we critically re-evaluate some of the ‘rules of thumb’ used in managing drawdown assets. The ‘4% rule’ might need to be replaced with a more dynamic, market-dependent strategy and yield-targeting.
This may lead to significant variation in portfolio risk over time and could need to be re-examined in the context of ongoing suitability.
Segregate your accumulation and decumulation portfolios
Clear segregation of clients and distinct propositions aligned to clients’ risks and objectives might help advisers meet their PROD obligations.
The world of decumulation might sometimes appear unnecessarily complex and confusing but these five steps should help bring more transparency and clarity for both advisers and their clients.
Justin Onuekwusi and Andrzej Pioch are multi-asset fund managers at Legal & General Investment Management.
This article first appeared in the June issue of Retirement Planner’s sister title Multi-Asset Review, which is now out. To make sure you receive your own copy of the next issue, please do register your interest here