Blending Solutions At Retirement

I was recently asked by a journalist to comment on the idea of ‘blending’ solutions ‘at retirement’. In other words, securing the guaranteed income of an annuity with some of the funds and remaining invested with the rest. Don’t forget, with an annuity neither you or your beneficiaries will ever see the lump sum again. But remaining invested, and being able to access the lump sum for you or your beneficiaries, involves risk. Here is the feedback I gave the journalist.

General statements I would make about this before detailing two individual investor strategies are:

• It is certainly a credible school of thought to secure one’s critical core income via an annuity and then remain invested with any excess funds. Those excess funds may be in a pension or other investments, for example ISAs.
• A blind spot I often see is individuals, often men, planning an income for their life expectancy but not giving enough consideration to the possibility of them predeceasing their spouse. If not planned carefully, in this scenario the spouse's income may drop off the edge of a cliff. So serious consideration needs to be given to the annuity being in joint lives, second death. This may need to be 50% spouse's benefit, 66% or even 100%. Needless to say this is likely to significantly reduce the initial regular payment.
• For the drawdown element remaining invested, likewise consideration needs to be given to how the funds will progress in an ideal world. If on the pension holder’s death the value is to transfer to a spouse and the life expectancy of this spouse is longer (and this is often the case if the lion’s share of the pension is held in the name of the husband and the life expectancy of the wife is longer), then consideration needs to be given to an investment horizon based upon the spouse’s life expectancy. This may significantly alter a target asset allocation as noted below.
• For the invested drawdown element, as the client ages and life expectancy decreases the asset allocation of the investment likewise should be amended. Circumstances can change and the client's attitude to risk and reward can change. Their capacity for loss can change. So it is vitally important that the client/adviser stays on top of this issue and amends fund selection accordingly and regularly. This is where the role of a responsible adviser continuously supporting a client is so vital. Risk needs to be actively managed rather than necessarily totally avoided.
• When talking about ‘income’ now since 6 April 2015 with Flexi access drawdown available, the definition of the term now is much more loose than previously when government rates (GAD) dominated the agenda. Ultimately the client can take as much 'income' as they require on the premise that if they take too much, the value of the underlying fund will reduce, possibly to nil. We do have clients who are deliberately taking a higher level of 'income' than the fund is likely to be able to tolerate for long, in the clear understanding that the value will fall.
• When taking an income from an invested portfolio the client needs to be fully aware that if this level of income is higher than the annual growth of the fund, the fund will fall. If a few years of this occur, it is perfectly possible that the fund will never recover or even maintain its value. This is why regular reviews are so important.

Case study one - A client who is a cautious 3/10 investor with a ten-year horizon we may recommend they initially invest in a portfolio consisting of;

Government bonds 42%

Cash 10.5%

UK equities 18%

Index-linked bonds 9.5%

Property 10%

Overseas equity 10%.

• This may well be for a client who is nervous of risk and/or loss and who relies to a greater or lesser extent on the income from these funds.
• This may well be a single person who believes that on their death, the beneficiaries will withdraw the pension into cash, for example to clear debts. Or they may plan to actively erode the fund to nil over their lifetime.

Case study two - A client who is more adventurous 7/10 with a 30 year investment horizon we may recommend they initially invest in a portfolio consisting of

Overseas equity 50%

UK equities 15.5%

Specialist equity 5% (for example medical or technology)

Corporate bonds 19.5%

Property 10%

• This client may well be married with a strong likelihood that at least one of them will live for a significant period.
• Likewise this may well be for a client who knows that the beneficiaries are likely to remain invested. Smart clients are allocating pension funds on death to their children and agreeing with them that these funds are to remain invested to help them with their own retirement income planning. Having such a lengthy investment horizon allows the portfolio to be invested more creatively and with the likelihood of better returns, albeit with greater short-term fluctuations. This scenario I believe, is where a pension revolution is likely to take place with children (currently suffering under the weight of student loans, the need to generate a deposit on a property, the need to save a significant pension pot), massively advantaged by responsible parents and grandparents bequeathing these funds entirely tax free.