There is no doubt Covid-19 has changed the way people live and organise their finances: from planning for the future, buying or selling a home, saving for their children or drawing down their pension pots.
Financial information business Defaqto has recognised these Covid-19 challenges and has produced a CPD-accredited guide ‘Drawdown review guide: How to assess ongoing suitability’ to help advisers and paraplanners with giving sustainable and suitable advice to their clients.
According to Defaqto, Covid-19 has not only changed the way financial advisers work, but it has also brought with increased uncertainty. Stock markets around the world fell by up to 35% between the start of the year and late-March, creating the perfect storm for those in drawdown that many may never fully recover from, primarily due to sequencing risk.
David Cartwright, head of insight and consulting (wealth and protection) at Defaqto comments: “Income sustainability is crucial, especially at times of increased volatility. Our guide is designed to provide an understanding of the concern’s clients may be experiencing in the current climate. It then explains the key steps to consider in a drawdown review, including identifying vulnerable clients.
“Importantly, with our guide, advisers will be assisted to navigate the key aspects of the drawdown review process and further ensure that the advice they give is suitable.”
Receiving the income expected is critically important to drawdown clients. However, the probability of income being sustained for the client’s chosen term or lifetime changes daily, as the underlying investment capital value and income yields vary. Even more so in times of a global crisis, like COVID-19.
A client may expect a specific income from their drawdown arrangement, but many may not have considered sustainability. Therefore, it’s down to the adviser to educate their client on what a sustainable income drawdown rate should be.
There are six identified key factors that impact sustainability for advisers to consider in a drawdown review:
- Initial capital balance
- Withdrawal amount, i.e. income
- Duration (the term the withdrawals are required for)
- Level of sequence risk
- Reduction in yield, i.e. cost
- Residual capital (the amount the client wishes to have at the end of the duration)
When an income requirement is not being met, advisers have an array of options to consider including, restructuring the portfolio, reducing withdrawals to a sustainable level, suspending withdrawals for a period of time, stopping withdrawals entirely, at least partial annuitisation and taking into consideration a client’s wealth outside of the drawdown arrangement.
The exact impact on income drawdown “remains to be seen” according to Jon Greer, head of retirement policy at Quilter: “As the Coronavirus job retention schemes and furlough measures wind down, more companies will be confronted with tough choices about which staff they can afford to retain. Older staff that find themselves out of work may choose to retire earlier than planned and others will use their pension to replace their income while they look for a new role.
“Provided people plan carefully, it can make sense to utilise pension assets this way. But it is really important to remember that drawing down your pension earlier can have a big impact on its longevity. Similarly, if you take flexible income now and then return to work at a later date, your contributions may be limited due to the Money Purchase Annual Allowance.
“It will be really important that as people confront these key retirement choices, financial advisers are on hand to provide expert guidance and pension companies encourage everyone to speak to a financial planner or make use of government-backed services like Pension Wise.”
Others think that there has been ‘no impact’ in relation to income drawdown.
Scott Gallacher, director and chartered financial planner (CFP) at Rowley Turton says: “Due to ‘lockdown’ many people have actually spent much less this year due to cancelled holidays, no going out, smarter food shopping, for example. So many people’s income need will be lower than normal this year, so that’s less money to be drawdown this year.”
Darren Cooke, CFP at Red Circle Financial Planning says: “[There has been] no impact at all. Investment portfolios are all but back to the same level as a year ago and any drawdown strategy should be able to withstand the temporary falls, we saw a few months ago.”