Drawdown for the mass market
Ever since the pension freedoms were first announced I have been asking the question ‘what does drawdown for the mass market look like’?
The answer to this question lies in tackling two important issues;
- Who is drawdown suitable for
- Which products are most suitable?
Suitability and advice
Traditionally drawdown has been regarded an option only suitable for higher net worth clients but people like me have long argued that drawdown should not be elitist. In the right circumstances it may be appropriate for those with more modest pension pots to invest in drawdown. The issue is not so much wealth but suitability and this is an advice heavy exercise.
There can be no denying that the question “annuity or drawdown” may be one of the most difficult financial decisions for both advisers and their clients. I can recall situations where people who purchased annuities would have been better off in drawdown and some who invested in drawdown probably should have purchased an annuity. The right answer is only evident after the passage of time.
One of the reasons why the decision is so complex is that it is often presented as a black and white choice. In my experience some of the best outcomes have been achieved by a combination of annuities drawdown. Arguably this can take twice as much advice time as a single option solution. See what I mean about advice heavy.
Which products are most suitable?
Generally speaking there are only two things that matter;
- Investment choices
- Plan charges
The fund choice and the amount of risk the drawdown plan is exposed is to critically important. If the returns are too low the drawdown will not provide the same income that could have been purchased from an annuity. If too much risk is taken there is an increased risk of running out of income in the future.
I have always thought that one of the difficulties with drawdown is that a higher rate of return is required at older ages in order to maintain the annuity purchasing power but at this time people should be taking less risk not more. The reason for this is the effect of mortality drag which can be explained as an invisible force that acts to boost annuity payments.
There is probably no disagreement with advisers that drawdown is better with a bespoke investment strategy rather than a one size fits all approach. The problem is that the mass market does not have bigger enough funds to justify bespoke solutions.
I think the part of the answer to the mass market drawdown question could be the new hybrid or combination solutions which are being launched by companies such as Partnership. These plans offer a combination of annuity and drawdown style income in one single plan with one monthly payment. Not only do these plans allow people to move from drawdown to annuities very easily they also make the administration extremely easy because there is one combined payment net of tax.
I confess my interest as I am writing a customer guide to combination plans. But it seems to me that the option to arrange a drawdown plan which can provide a level of guaranteed income will act to reduce the over risk of taking retirement income. The low cost passive funds help to keep down the cost of drawdown without necessarily compromising the potential for investment growth.
There will be an opposing school of thought that if a combination of annuity and drawdown is needed it can be done better by arranging two separate policies.
It is probably a question of scale. The bigger pots will benefit from bespoke advice and best of breed plans but the mass market need a solution that is suitable for purpose and cost efficient.