Guest Spot: Exploding retirement income myths #2

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  • Author : Just
  • Date : 10 May 2021

For adviser use only.

We use drawdown so we can pass money down the generations – don’t we?

Only a generation or two ago, retirement was something that happened to you. Those in the pre-baby boomer cohort reached a certain age and collected their gold watch for lifelong service. Even though they no longer had to show up at work, they continued to get paid by their employer in the form of a nice and stable monthly pension… You didn’t have to do anything or decide anything, it all just happened.

Now, for all the reasons we are very familiar with, the majority of us will spend our later years having to make significant financial decisions, managing trade-offs and accepting that retirement is ultimately a compromise… We can no longer be passive and just let things happen.

Many will use the professional services of a financial adviser. They trust the adviser will use their knowledge and experience to advise them on the right balance between their wants and their needs, or in regulatory language, manage the sometimes conflicting needs and objectives of their clients.

Understandably, because we’re only human after all, a retiree’s wants are often focused on a desire to continue to protect and nurture their family by aspiring to pass on capital to loved ones after they’re gone. However, this want is often at odds with reality and the need to use this capital to provide themselves with sufficient income to meet their continuing lifestyle expectations. The art of the adviser, is balancing these competing requirements and finding the optimal way of achieving sustainable income with one eye on maximising legacy provisions. The answer when it comes to pension assets is typically the capital markets and flexi-access drawdown, and why not?

Well, most art has some science behind it, just take Michelangelo and the Golden Ratio as a classic example. When we start to look through a more scientific lens at how best to balance these competing retirement needs and objectives, some interesting data emerges.

It feels intuitively right, that if providing a legacy is a relatively important priority, then a sound strategy will be to maintain the capital base and invest it in a well-diversified portfolio. But is that intuition right in terms of it being the optimum approach? To answer this we need to consider two things.

Firstly, when is the legacy event most likely to occur. Average life expectancy is now commonly understood to be the point at which mortality data suggests the cumulative risk of dying is the same as still being alive, ie 50/50. It therefore makes planning sense to try and ensure that legacy potential is optimised from this point forward as the cumulative risk of dying increases. It should obviously be noted here that some people do not achieve average life expectancy and an individual’s personal and family history needs to be taken in to consideration.
The second thing to consider is linked to the first, although this may not be immediately obvious, and that is what ‘assets’ do you invest in to achieve this optimum journey? It has become increasingly difficult to truly diversify a portfolio as diversification requires assets that are non-correlated. There is however, one investment opportunity a retiree has that others do not, which is to gain exposure to the potential value of mortality credits by using some of the portfolio to purchase a guaranteed income for life.

As you can see in the modelling chart below, using just over 25% of a £400,000 portfolio to buy Secure Lifetime Income via the Novia SIPP helps to increase the projected asset value from around age 86 onwards compared to a typical 60/40 equity/bonds portfolio, thereby optimising legacy potential when it is statistically most likely to be called upon.

Example based on bottom decile of a 1000 economic simulations, SLI scenario includes cash in value, asset allocation 60% mature equity, 40% investment grade bonds, 1.75% total fees, £5,000 level non-discretionary income, non-discretionary income provided by SLI in SLI scenario, rate based on fit and healthy persona aged 65, £3,435 discretionary income escalating at 2% p.a.
There’s obviously some information around the chart and the modelling above, but hopefully the point is clear… If as an adviser, you need to try and balance competing objectives of reliable and sustainable income plus planning for optimal legacy provision, accessing mortality credits through a guaranteed income solution such as Secure Lifetime Income (SLI) can help you improve portfolio values when it matters most!

To find out more about integrating SLI into drawdown portfolios please get in touch with your Novia or Just account manager.

Notes

The statements and opinions expressed in the Guest Spot are those of the author and do not necessarily reflect those of Novia Financial plc or any of its employees. The company does not take any responsibility for the views of the author. Any links, web pages and documentation within the Guest Spot are provided by pages maintained by independent third parties and Novia accepts no responsibility for the availability, content or use of the information contained within them.

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