Ryan Medlock: Well, I think one of the main advantages of a drawdown is definitely the flexibility. If you think about it from an income perspective, obviously, there are no rules, there are no limits in terms of how much income can actually be taken. That can obviously be used to suit the individual needs of clients and obviously, if used effectively, it can be used to generate a sustainable level of income in retirement, but it’s also not flexible just in terms of income.
In can also be flexible if we think in terms of intergenerational planning. Obviously, if you’re taking out an annuity, at that point, the money is exiting the pension system. If you’re going into drawdown, then on death, the pension pot can be passed down through the generations in a tax-efficient pension wrapper. Most people will, undoubtedly, love to spend their pot in retirement, but for some clients, it will be used as an IHT mitigation tool. There are a lot of differences between the accumulation and decumulation phase and a lot of inter-related risks which are specific to drawdown only.
So, again, I’m talking about things like sequence and risk, income sustainability, and capacity for loss. So, issues that a lot of clients just won’t be familiar with. That’s why I think it’s really, really important that advisors discuss these issues with their clients, bring them to life and really give them an indication of what sort of impact and effect they can have on their retirement savings.
Flora Maudsley-Barton: When I’m explaining drawdown products to clients, I actually avoid using the words that, between myself and another advisor, we use quite a lot. I rely more on a conversation and a story. So, I’m going to avoid using words like flexi-access drawdown, even FAD, because it doesn’t mean anything to them.
They need to understand how the drawdown that suits them, suits them and how the pitfalls are going to apply to them. I need to understand all the products. I need to understand what they mean, but I don’t need to be displaying that in a conversation with them.
Keith Churchouse: We normally do it via diagram and just to take them through the process of retirement planning from where their existing pension benefits are, whether they want to take a tax free cash, whether they want to consider an annuity purchase, or whether they want to consider things like income drawdown or a bit of both.
Also, whether there are important issues within their policy, such as guarantees that might have greater value than the flexibility of an income drawdown. The death benefits, the way income can be produced, and also, the way that maybe they would want their overall benefits to pass on at a future time, again, sort of, death benefits.
Craig Palfrey: We’re talking to the client about their financial freedom date rather than their retirement date, because I think retirement, the landscape has changed massively over the last couple of years, well, the last couple of decades.
I don’t think retirement is as simple as it was, but ultimately, we take them on a journey of where they’re trying to get to. So, someone famous once said, ‘Start with the end in mind.’ That’s what we’re trying to do, help them understand where they want to get to, then how their pension can help them facilitate that journey, and ultimately, when we talk about the drawdown, we’re just explaining to them, it’s almost like a bank account.
There are some tax implications, there are some risk implications, depending on what they’re going to do, but ultimately, it is a bank account. They can, nowadays, draw from it, pretty much, however they want depending on their needs, and I would suggest seeking advice
RM: I think drawdown has gone from strength to strength, in terms of popularity. If we looked at the advised drawdown market, we know the latest figures suggest that drawdown sales are continuing to outpace annuity sales in the region of four-to-one actually at the time.
If you look at average case size, it’s definitely a case of, as the pot size increases, so does the popularity of drawdown. What’s actually interesting is, we’re about to come into a particular wave where we’re about to be seeing about 800,000 people per year, across the UK, hitting the age of 55, and that’s pretty much a trend which is going to continue for the next three decades. So, I think we’re only going to see the popularity of drawdown increase over that particular time.
KC: Flexibility is key. Historically, annuity rates have not been high for many years. That doesn’t mean that in years to come annuity rates will rise and the advantage of an income drawdown is that we can switch to an annuity at a later date, and that’s something that we’re adding into our text with clients, in the fact that later on we may still consider an annuity.
Flexibilities are good, but there are some downsides, charges on income drawdowns can be high. If a client wants to take an unreasonably high level of income drawdown, then they’re going to be depleting their fund. Can they cope with that risk?
FMB: I think client’s like drawdown because they like control, the perception of control. I also think drawdown is obvious to customers, it’s quite instinctive to them, the idea that they will spend during retirement that which they built up in the run-up to retirement and if they can have their basic needs met with a final salary pension or with a state pension and any other source, then drawdown is obviously attractive.
Also, if it’s a large fund then drawdown can be attractive. I don’t think it’s ever a no-brainer though. I think there are always advantages of secure options and there are always advantages of flexible options.
CP: So, drawdown products are attractive now because the flexibility is there. Up until a couple of years ago, they were restricted in terms of what you could draw from them, but when Steve Webb, sort of, lifted the lid and said, ‘You can do what you want,’ they became attractive to everyone, because, as I said earlier, you can use them like a bank account now.
So, they’re flexible, you can leave them behind to your kids, which is becoming a big reason for people to do it, but I think the key thing is to tell people, to tell clients is that pensions are for life not just for Christmas, and they have got to provide them with an income for life. There are people taking it all out too early, which obviously, we try to discourage, but ultimately, Steve Webb’s told them they can do what they want.
RM: So, I think it’s fair to say when MiFID II first came into effect over eighteen months ago it slipped under the radar a little bit, but make no mistake about it, it is having a massive impact on the industry including the drawdown market. I think if we go back to just before MiFID II came in, there was a lot of background noise about advisors having to obtain legal entity identifiers, recording client phone calls, but what we’ve actually seen is more pertinent issues rising to the fore.
So, things like the 10% drop reporting, suitability rules, the introduction of the new PROD rules, and indeed the cost and charges disclosure requirements. So, the Product Governance Requirements, or PROD in short, is another significant impact of MiFID II. It’s important to remember that PROD applies to both MiFID II and IDD business, so it casts a much wider net than, say, the cost and charges disclosure requirement does. Now, this is a new part of the FCA handbook, and as such, these are rules.
If you aren’t complying with these rules, you are at risk of enforcement action. Now, whereas MiFID II was more focused on the increasing transparency, PROD is more about the target market and client segmentation strategies. So, putting all of your drawdown clients into the same centralised investment proposition as your accumulation clients is unlikely to be the best thing as far as PROD is concerned. Now, our research at Royal London does highlight that just under 40% of advisors use the same investment process for accumulation clients and decumulation clients.
KC: I mean, with anything to do with pensions, there are always tax considerations. Starting with tax free cash, what level they want to take. The value of pension funds is outside the estate for inheritance tax purposes up to the age of 75. Do they want to protect the family, and if so, how do they want to do it?
Whether they are a higher rate or basic rate taxpayer, or a nil rate tax payer, and what would happen if they took income? What would happen to their end tax rate? If they want to take a lump sum from their pension as a taxable income early in the tax year, then we can find that the revenue who are always tax hungry are taking a larger slice of tax at the outset. You can reclaim it but again, that’s a cashflow issue that the clients need to consider, and as mentioned before, the death benefits need to be thought through, as to how they would want their benefits to be passed onto their loved ones if at all.
FMB: The tax considerations that clients need to be aware of, first of all, it’s worth reminding them that once they’ve had the tax-free cash, that the pension that they receive, in whatever form, is going to be taxable. In conversations, I find that people react better to sort of, round number and estimates.
So, a basic rate taxpayer might end up paying around 15%. A higher rate taxpayer, about 30%, and so on, and I find that’s easer to talk to than do a calculation and get it right in the meeting. Also, there’s the big one, the big tax consideration. If people want to draw the whole lump sum, it’s good to get that out there and explore that, and I will usually remind them that the chancellor wants their share first, so that hopefully stops them from looking at the fund value and expecting that to hit their bank account.
CP: The first thing is just don’t take all your tax-free cash because someone told you you should when you retire. I think you should be looking at what you need and only taking what you need because a pension is still underneath the bonnet of the most tax-efficient vehicle you can have when it comes to long-term growth.
What people aren’t doing enough of, I believe, is that they aren’t using their personalised allowances. So, a lot of clients will retire at, let’s say, 62, they’ll take their tax-free cash to get them through to 66, and then they’ll start drawing their pension income and their state pension. All of a sudden, they’re a taxpayer again, when actually, during those years of 62 to 66 they were missing out on their personal tax allowance.
The other thing people don’t realise they can do is they can recycle some of their income. So, every year, they could be taking out 3,600 worth of income, paying a bit of tax on it, depending on the situation, putting it back into a pension, and then having another dollop of tax free cash in a couple of years’ time, and that’s added some real value to some of our clients over the last couple of years, but that’s not considered by lots of people, because it’s such a small thing, but every single bit, you know, adds up.