Almost a decade on from pension freedoms, the Financial Conduct Authority’s retirement income advice review, published in March this year, notes the growing complexity of decisions for clients approaching and in retirement.
The review identified a set of best practices – but from my conversations with advice firms, I know it is not only clients for whom this is a complex topic.
At the heart of the issue are four big questions.
First, how do you use risk profiling for clients in retirement?
The regulator identified this as a key area for improvement. Risk profiling was found not to be evidenced, or was not consistent with the customer’s objectives, knowledge or experience.
This is a concern because, as the FCA highlights, the shift from accumulation to decumulation is a period when attitude to risk is likely to change for many customers.
Older clients are notably less risk tolerant. That means risk preference needs to be reassessed at the point of retirement – as a minimum, because for most people the shift to decumulation is not a one-and-done, but a more gradual transition.
Both in and before retirement, attitude to risk is best measured with a consistent model, so the adviser can see how it is shifting, and can be sure that any shift results from a change in the client’s thoughts, feelings and preferences, rather than a change in the method being used.
Risk in retirement is also complex and multifaceted.
It is not helpful simply to switch an instrument in a client’s portfolio because they want to take income, even if the portfolio remains consistent with an up-to-date risk profile.
Most people in retirement will need both long-term growth and income. The client’s willingness to take risk is just one step in working out the right combination.
That brings us to the second consideration: the client’s capacity for loss.
The regulator noted that some firms were not assessing capacity for loss as part of the risk profile, resulting in a failure to identify suitable solutions.
At one end of the spectrum is someone who retires with so much money that they can achieve their needs and wants without stress – the dream position to be in.
At the other is someone for whom money is so tight they are going to struggle to meet their basic needs, and for whom the best answer might well be an annuity.
Most advised clients fall somewhere in the middle: they need to continue to take some risk, particularly early in retirement, to benefit from compounding and achieve the returns they need to combat inflation and maintain their standard of living.
But their capacity to do so will vary significantly and, as most advice firms now recognise, can only really be understood by running a full-blown cash flow.
A robust cash flow tool can ensure client income requirements are taken into account appropriately and sustainable levels of income can be generated from the chosen solution.
