Cast aside your preconceptions, says Michael Wilson, Editor-in-Chief at IFA Magazine. Times are changing.
First, the good news. Fears that the 2015 pension freedoms would prompt a huge outflow of DC pension funds from the over-55s appear to have been overstated. As 2016 drew to a close, it appeared that Q4 drawdown rates were stabilising at around £1.56 billion – unchanged from the third quarter, and not so very far above the quarterly average of £1.35 billion for the whole seven quarters since the freedoms began.
No tidal wave of encashments there, then. And in a way that was fortunate, because London’s equity markets had a strong year, with the FTSE-100 gaining 14.4% and the gilt yield trending convincingly downward. 2016 was a good year to have stayed invested.
The less good news, of course, is that 2017 is proving much harder to call. For reasons we don’t need to count, the pensions industry is expecting a sizeable rise in drawdowns this year. And Aegon is only the latest provider to be asking whether clients should still be expecting to draw down the good old 4% per annum of their starting capital (adjusted for inflation) that the good old Monte Carlo simulation has been indicating for so many years now. Or whether 3% adjusted might now be a better ‘safe’ rate for a 30 year retirement where the portfolio is split 60% equities and 40% bonds (plus a little cash).
Changing parameters, closer focus
That shouldn’t shock us particularly. Only last year, Morningstar’s own study indicated that a 4% drawdown would provide only 78% probability of success over 30 years, against 90% for a 3% drawdown rate. And, as we reported in February’s IFA Magazine, Investec Structured Products has also queried the 4% rate – with a side recommendation that structured products may well present a viable way of handling risk and securing guaranteed incomes. But the Aegon paper (“What’s the new sustainable income rate in retirement?”) is possibly the most focused study yet.
Firstly, says Aegon, the 4% rule of thumb was calculated in 1994 by an American, William Bengen, with specific reference to the US investment market – which, as you might have noticed, has performed differently from some other countries since then. Secondly, the traditional assumptions have been skewed by changing treatments of factors like IHT or the huge growth of housing equity, which offers the elderly a backstop that they didn’t used to have. And which might have impacted on their capacity for loss.
Open your mind. And the client’s, too
Thirdly, longevity has grown faster in the UK than in the US, so that 30 year pot won’t last as well as it used to. (Especially if dementia risk cranks up the costs.) To which I’d add that you’d have to have a very special reason for wanting a 40% allocation in fixed interest during a year when so many indicators point toward significant capital risk for bonds. Phew.
But what I do like about the Aegon report is that it urges advisers to open up their minds to new thinking about how clients’ needs and aspirations shape up to their risk tolerance. And about how both advisers and their clients need to revisit their assumptions.
Aegon’s proposed ‘sustainable income’ rates? 3.23% over 30 years, 2.93% over 35 years. But those are just benchmarks. Read the full report for the maths.
