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Pension Budget Reforms 2014

 

The Chancellors latest budget changes have created a seismic shift in the retirement market. The reforms will dramatically increase scope for setting up innovative drawdown plans to facilitate the new rules, allowing savers to access the entirety of their pension plans at any time from age 55.

However, because managing drawdown is technically very difficult, one wrong decision could have a detrimental impact on the rest of an individual’s retirement.

With drawdown the personal consequences and regulatory risks of getting it wrong are high. However, advisers should not expect to rely on a readymade solution. It may seem the solution will be institutional, as life companies replace annuities with a product in which the rate of draw is a managed outcome.

Initial thoughts were that the life companies would provide new products in place of annuities to provide a plan in which the rate of income drawn is a managed outcome.

This is the sort of solution the Department for Work and Pensions prefers, hence it is backing collective defined contribution plans in which both investment and longevity risks can be pooled.

However, retirement funding is process driven not product driven, meaning a fund is used to draw upon rather than being managed for growth and income, to the detriment of the performance.

I addition, many individuals may feel averse to such a product given bad previous experiences with endowment, with profit and pooled investment products

Removal of the Government Actuary’s Department (GAD) limits

Removing the Government Actuary’s Department (GAD) rules is an opportunity to define a new approach to achieving capital efficiency for a household.

Advisers will be setting-up drawdown plans for clients piece by piece and must avoid any problems or errors along the way. As part of a holistic solution to retirement funding involving pension assets, other savings and even freehold property, it has to be specific to each individual in a way products cannot be.

Managing Drawdown

The technical challenge of managing drawdown calls for stochastic modelling, the only way to make a highly-customised approach cost-effective; quite apart from the other advantages of consistency and objectivity that quantitative decision processes can bring.

The same model can be used both to plan a holistic retirement goal and to manage the assets.

A helpful development will be the platform technology that portfolio models depend on.

The technology already exists and is currently used to customise the benefits offered to wealthy clients but can be captured at much smaller portfolio sizes.

Portfolio models are set taking into account risk profiles and portfolio sizes.

Portfolio Models

Assignment to a portfolio model can be managed systematically constantly suiting an individuals needs.

The information needed to assign an individual to a portfolio model at each stage consists of the planned spending profile at different ages (hence the ‘duration’ of the plan), risk tolerance and market conditions.

A modelled approach to drawdown is compelling on many fronts. It can make portfolios more resilient to stress, which is important to investment professionals. Changing the entire conversation to one about spending outcomes turns what looks like an investment-management method into a continuous process of financial planning.

Compliance risk is also better managed because the process generates its own audit trail of logical and consistent discussion and decision.

The inputs needed from clients will be familiar to advisers accustomed to assessing income and expenditure. But there the comparison ends. What needs to be modelled are the outcomes of a lifetime plan, not a static portfolio. It can start at any stage, when accumulation begins, and continue as long as an annuity is avoided.

Model Outcomes

The modelled outcomes are expressed in real terms and only the individuals marginal tax rate is needed to calculate actual monetary figures at each review, which is set by the individual.

Outcome projections can be continuously benchmarked against both a level annuity and an inflation-protected annuity as well as against a risk free portfolio in which only longevity risk remains exposed, identifying the cost and benefit of insurance.

Drawdown Underperformance

Quite apart from exhausting the capital contained within the drawdown plan, the main issue will be investment underperformance which will reduce the plans value and in turn future income levels.

This is assessed within an individuals risk profile and takes into account an individuals capacity for loss and represents the importance of providing the right advice and using the correct model.

Conclusion

With the introduction of automatic enrolment in the form of compulsory workplace pensions, there will be a greater need for financial planning in the future with more people having a usable pension fund and entering the retirement market.

This has already been evidenced in the U.S.A where automatic enrolment and retirement benefits are becoming one of the fastest growing financial sectors propelled by hundreds of millions of Dollars in venture capital and a raft of technological developments, including pension portfolio modelling.

The above article clearly shows the need for a change in approach to retirement planning incorporating technology, platforms and even discretionary fund management.

The need for high quality advice from industry, regulators, Government and financial advisers has never been greater.

Further information on the new pension rules can be found via the following link to the Money Advice Service, the Governments free, unbiased advice website:

https://www.moneyadviceservice.org.uk/en/articles/new-rules-about-pensions-from-27-march-2014


 

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