When the pension freedoms legislation was announced in 2014, it promised more choice around how people could use their retirement funds.
However, while the freedoms gave mass market consumers greater flexibility over their pensions, they also created the challenge of managing investments and selling down funds to deliver an income in potentially unfavourable or volatile market conditions and exposed more retirees to the risk of running out of money too soon.
Managing these risks effectively is a complex task, yet Financial Conduct Authority figures show that only a third of people take advice when accessing their pension pots for the first time.
Even for financial advisers, managing risk throughout the decumulation journey is far from easy.
The FCA’s thematic review of retirement income advice, published earlier this year, stressed the potential for significant harm if retirement income advice is unsuitable and highlighted several areas of concern, particularly around risk profiling and the assumptions used in cash flow modelling for clients in drawdown.
Assessing risk in decumulation
The regulator stated in the review that risk needs to take account of consumers’ objectives, which for most retirees is generating a sustainable income.
It seems obvious, but attitude to risk can change depending on the circumstances.
Clients might be happy to take a high level of investment risk while accumulating pension savings when they have time to ride out periods of volatility, but be far less willing to take risks with income that is funding their lifestyle in retirement when there is less opportunity to recover investment losses.
EV’s own data, drawn from its dedicated risk questionnaires for growth and income objectives, shows those investing for income are significantly more risk-averse than those investing for growth.
Cash provides a good illustration of why it is necessary to take a different approach when quantifying risk to income.
While it may be a low-risk option for those in accumulation, in decumulation, the interest earned has a major influence on the level of income that can be drawn.
As history has shown, interest rates can vary considerably, even over short periods, making cash not a risk-free option for delivering income.
Therefore, while cash can be a good short-term tactical option if it is thought that markets may fall substantially, it is not a good low-risk, long-term investment for decumulation. Long-term cash investment is very likely to affect income prospects adversely.
Advisers need to know how their client feels about the possibility of their money running out sooner than expected or having to live on a lower income than planned during retirement.
However, a decade on from the pension freedoms, the industry is still too focused on accumulation, with too few specific processes and tools to support the decumulation journey.
