The FCA is currently finalising its Retirement Outcomes Review, looking at the retirement choices made by pension investors. Contributor Nathan Long, Senior Pension Analyst – Hargreaves Lansdown. Amid concerns that people might run out of money in their retirement, a new Hargreaves Lansdown research paper sets out a solution to the conundrum of how to help the retire-as-you-go generation manage their investment and income withdrawal strategies in retirement.
Evolving retirement patterns are causing concern, as people are shunning the security of a guaranteed income for life from an annuity, in favour of a more flexible approach.
Hargreaves Lansdown has written to the FCA outlining a guided drawdown solution that provides retirees with both an investment and a sustainable income strategy for the mass market.
Retirement can easily last in excess of 30 years; solutions must ensure capital is not depleted so people can adapt to their changing circumstances (which we anticipate will still include buying annuities in later life for many).
Drawing only the income generated by your investments – known as the natural yield – is a simple, cost-effective and transparent solution. It provides a ready-made investment portfolio, a sustainable level of income withdrawal and preserves capital, meaning options are left open. Active investment management is necessary to move between asset classes and to pick high and sustainable income producing investments.
Nathan Long – Senior Pension Analyst at Hargreaves Lansdown ‘The regulator is rightly concerned about the risk of collateral damage created when George Osbourne tore up the retirement rule book with the introduction of Pension Freedom. Increasing numbers of the retire-as-you-go generation want to get on with sensibly managing their retirement savings but some of them need help and guidance. Progressively fewer people will reach retirement with a defined benefit pension, so now is the time to focus on offering investors guided drawdown options.
Drawing only the income generated by your pension investments – taking the natural yield – is a great simple solution for investors who know they want drawdown, but don’t know where to invest or how much they can take. ‘The word default should be banished from retirement though, as hugely personal choices don’t lend themselves to a one-size-fits all approach. People want to keep their options open and stay in control of their changing circumstances. Life after work can last over 40 years, so income and investment strategies have to be built for the long term. This also means any guided solution has to involve active investment management to adapt to changing market conditions.’
Natural Yield for drawdown
Drawing only the income generated by your pension investments – the natural yield – is well suited to drawdown because: It is relatively simple. It dictates the income level as well as the investment strategy, which delivers inbuilt protection for individuals. It provides a sustainable income; we can be confident that people will not run out of money. It allows additional capital withdrawals with a clear indication of implications.
Taking natural yield means that people in drawdown are not required to make decisions on when to buy or sell investments, but instead can rely on the income that is generated from holding their investments. The design of the investment approach is important, but so too is discipline around withdrawals from the pension; you could have the best investment strategy in the world but if you take too much income you’re still risking running out of money.
The retire-as-you-go generation
The transition from work to retirement is becoming more flexible and dynamic. Part-time working looks set to be increasingly important for older workers for both financial and social reasons. This next generation will need to keep their options open and have a retire-as-you-go approach, to cope with all the twists and turns that come as they age. Many of these people don’t even think of stopping work, they think of how they can continue doing what brings them enjoyment as they age.
The three types of drawdown investors
Retirement is hugely personal and there is no one-size-fits all solution. In fact among drawdown investors we have identified three distinct groups:
Those that are not yet drawing an income but have accessed their tax free lump sum. Arguably they are not really drawdown investors at all as their motivations remain to grow their pension pot. Those that are prudently managing their pension to provide an income for life. Those who are taking ad-hoc withdrawals because their income needs are met from other sources.
Evolving retirement patterns
Retirees have been quick to shun annuities, but clues hidden within the patterns that are developing point to a still evolving landscape. Stock market volatility or a shift in Gilt yields could quickly change the appetite to buy secure income. We believe a return to the annuity rates last seen in October 2013 could see 46% of those retirees in search of secure income buying an annuity.