By using tools that measure risk to income, rather than risk to capital, it is easier to stress test the proposed investment solution and assess suitability against the client’s risk profile and objectives.
For instance, when thinking about a low-risk income solution for retirement, an annuity is the obvious answer. However, the inflexibility of an annuity purchase may put people off buying one at the start of their retirement.
Using cash flow modelling and realistic forecasts will make it easier to compare the benefits of buying an annuity, using drawdown or taking a blended approach to achieve the client’s objectives within their risk appetite.
Even if an annuity is decided against at the outset, the comparison can easily be repeated at regular income reviews to see if the attractions of annuities outweigh drawdown as the client ages.
The FCA will probably continue to pay close attention to the assessment of risk in retirement, stating in a recent “Dear CEO” letter to advice companies that it is “following up the findings of the thematic review and with firms and carrying out further work to explore the scale of any issues identified and tackle any harms”.
Many low to medium-risk retirees today are using investments for drawing an income that exceeds their risk tolerance, exposing them to potential financial harm, with few options to recover from serious losses.
Companies need to use the appropriate tools to assess the client’s income risk profile and make sure the output from the questionnaire is mapped to suitable income drawdown solutions in a reliable way.
By ensuring that risk remains aligned throughout the decumulation journey, advisers can be sure of meeting the needs of both the regulator and their clients.
Chet Velani is managing director of EV
