More than nine years after pension freedoms were launched, people are still calling for help when they reach the point of drawing down their income.
You’d think helping people make the most of their hard-earned pension funds in retirement would be a national priority. However, there is very little government guidance on “best practices” in this trickiest part of financial literacy.
As a nation, we need this help. Research by asset manager Abrdn published this week found that 23 million people (44 per cent of UK adults) have poor financial literacy, as evidenced by their inability to answer basic money questions. Nearly seven in 10 (66 percent) could not determine that buying a single share in a company carries more risk than buying a fund that invests in the stock market on your behalf. And 42 percent failed to figure out that if their money earns a lower interest rate than the rate of inflation, it will lose its purchasing power.
Meanwhile, another new report from Scottish Widows reveals a mismatch between what people want from their retirement income and the products they actually choose.
Eight in 10 people say they want a product that provides guaranteed income for life – yet few customers buy annuity products that offer just that. And more than half (55 percent) said that predictable income is important to them for budgeting, yet most people currently choose a product where their income depends on the return on investment.
These are basic elections going wrong. But the real choices are more complicated – annuities come in different types with subtle but important differences. Additionally, most people who go after drawing income face several challenges in managing their investments while drawing income. Keeping up with inflation is one thing, while “income sequence risk” — the risk of negative market returns occurring early in retirement — is another.
Pete Glancy, head of policy at Scottish Widows, says: “Retirement options can be daunting and complex, and people who cannot afford an independent financial adviser can inadvertently make decisions that do not meet their needs. their families.”
Whether they get the right help, even if they can afford to pay for financial advice, is debatable. Readers may recall the findings of the Financial Conduct Authority’s Retirement Income Review in March, which revealed examples of bad practice across the market.
The regulator’s letter to CEOs of consulting firms outlined the shortcomings. The approach to determining revenue drawdown was applied without consideration of individual circumstances or based on methods and assumptions that were not justified or recorded.
Risk profiling was unproven, inconsistent with customers’ objectives and knowledge and experience, or lacked consideration of their loss capacity. Perhaps worst of all, some advisers did not ask customers about their expenses or research future income needs or lifestyle changes.
Technology should be able to help. But there’s a frustrating lack of free tools to help people figure out if their money will last until retirement. Guide.co.uk is one of the few decent ones, although I’ve heard more are being developed.
Put all the findings together and we have hordes of financially illiterate people going it alone. It’s a terrible situation.
There are positives. I have seen anecdotal evidence of people doing drawdowns on their own with a well thought out strategy. However, there is little collective research into what non-advised drawdown customers actually do.
So I welcome a new report from Interactive Investor that sheds light on this.
The investment platform found that DIY drawdown customers have more exposure to investment trusts and funds and are less weighted towards cash than customers in the accumulation or “growth phase” of retirement planning. There is also evidence that the use of investment trusts by drawdown investors is designed to ensure a reliable and regular income from their investments.
Popular drawdown portfolio holdings include Alliance Trust, F&C Investment Trust and City of London, all ‘dividend heroes’ who have been increasing payouts every year for over half a century. This trio of Steady Eddies is also highly diversified, which helps mitigate the impact of the inevitable volatility of stock market investing.
It’s also worth noting that Alliance Trust has announced a successful merger with Witan, which should reduce its fees. The share price of both trusts rose on the news, suggesting the market thinks the deal provides decent value for both sets of shareholders.
Interactive Investor also found that drawdown customers have increased their passive tracker fund holdings over the past two years, with five of the top 10 drawdown holdings now being passive funds. The platform thinks investors are attracted by low fees and ease of access.
This all seems very reasonable. An October 2023 paper by Anarkulova, Cederburg and O’Doherty concluded that a simple, all-equity portfolio outperforms the alternatives in all retirement outcomes, generating more wealth in retirement and providing higher initial consumption in retirement. Surprisingly, the full-equity strategy also compared favorably to capital preservation, where households are less likely to deplete their savings and more likely to leave a large legacy.
Meanwhile, a forthcoming publication by retirement income consultant Chancery Lane attempts to shed light on how a pension is invested. I had a sneak preview of the analysis which calculates the income and capital generated by investing £100,000 in different portfolio types over 20 years to 31 December 2023 vs. income from an annuity tied to the retail price.
It found that mutual funds provided the best overall performance, concluding that growth in dividend income from 29 major mutual funds was likely to “cope” with inflation. I note that the period analyzed in the study was particularly strong in terms of share market gains, but Doug Brodie, CEO of Chancery Lane, says: “The income from the share is decided twice a year by the board using the cash they already have. , while equity values are a simple reflection of this morning’s stock trades.”
It’s food for thought. And we need more of this type of research, especially independent research with no ax to grind.
There have been many calls for policymakers to address the near-retirement and still growing cohorts (and younger people) and encourage them to strengthen retirement security. However, they also need to ensure that people can confidently imagine their retirement income and how it will arrive. It may require significant innovation. And it will certainly require investment in education.
Sometimes the optimal retirement income solution comes with a certain amount of discomfort. An investor can be uncomfortable and still get a good result. Or maybe they need to feel uncomfortable to have a chance at a good outcome. Education will help them accept it.
So to build on the success of auto-enrolment and help people effectively engage in the key decisions that need to be made about drawing income, we need cross-party consensus. With political upheaval likely in the coming months, it is time for the Independent Commission on Long-Term Savings to focus on retirement income and address some of these issues.
Moira O’Neill is a freelance money and investment writer. It is held by F&C Investment Trust and the City of London. X: @MoiraONEillInstagram @MoiraOnMoneyby email: moira.o’neill@ft.com