Les Cameron, Head of Technical of Product and Sales Technical, considers the thorny subject of risk
It is often said that clients don’t want to take any risks in retirement so they choose products which they see as being risk free. However, is there such a vehicle?
Essentially there are two ways in which retirement income can be taken in the UK. Pension or drawdown. Post budget there are still two ways to take your money, with the notable “tweak” that you can drawdown your full pot in one go!
The New World Is the Old World…
The pension reforms are allowing providers the scope to innovate and provide products that meet the nation’s retirement income needs.
In the past, there was an apparent desire to attract the highest possible starting income. But with full access, will this become irrelevant?
When any income is possible will risk be more important?
What Are the Risks?
Given various different types of retirement vehicle may materialise will there be new risks in retirement? The pre-Budget risks should essentially be the same.
· Credit Risk
This is the risk that any provider could go bust. All providers have different financial strengths and broadly speaking, the higher the financial rating, the less chance of failure.
· Mortality Risk
Mortality risk is the risk that a client could die prior to “getting their money back”. In the new world it’s probably more nuanced. Spend too little and leaving a lot of pension unused, or spending too much and outliving your pension pot. Our do you outsource the mortality risk and buy an annuity – you know you’ll be getting an income for life?
· Annuity Rate Risk
This is the risk that annuity rates may decrease in the future. This will still exist in the new world so if there’s any chance of an annuity purchase in future this risk will apply.
· Capital Risk
This is the risk that capital may be eroded. When an annuity is purchased capital risk disappears as the capital has been spent. Managing income levels to protect capital, or sustain income levels will be an important part of the new retirement world especially with no GAD limits which would ordinarily drive income levels down to protect the capital.
· Investment Risk
This is the risk to future benefits due to investment performance. This risk only applies where there is an investment link, so conventional annuities are not affected by this.
· Inflation Risk
This is the risk that the real value of income may be eroded by inflation. Unless an inflation linked income is available this risk will continue to exist.
New world, old risks?
Risk and Planning
There is no risk free retirement and there will not be a risk free retirement in the new world
Should clients choose the risks they want to take or the income they want to make? The FCA doesn’t look at a customer’s bank balance for unsuitable outcomes– they look at the suitability report.
Whether it’s the old world or new, focussing on income and not on the risk can lead to unwelcome outcomes.
Choosing the correct retirement income solution should provide the client with the correct retirement outcome. This has not changed with the Government’s proposed changes.
A successful retirement will rely on successful planning and successful capital management.
