Pension freedom and choice

Posted by: Nicola Macdonald, on April 8, 2016.

The new pension legislation announced in the 2014 Budget “freedom and choice” paved the way for a radically different approach to how most pension plans would be accessed and the last 2 years appear to confirm that for those with larger pension funds, annuities are being purchased and used far less frequently.

But this freedom has presented some different challenges for those contemplating how and when to draw their pensions, in a recent paper “The Yin and Yang of retirement income philosophies” written by Wade Pfau and Jeremy Cooper, explores this in more detail.

The Yin and Yang of retirement income philosophies

In summary, though disagreements exist about the best approach, a cutting-edge retirement income framework must be able to translate client goals, needs, and desires into an appropriate product and asset allocation strategy.

The process must delve into:

  • How much retirement income is feasible
  • How to best spread spending power over the course of retirement
  • How to allocate among various products differing in the amount of control and guarantees provided
  • How to choose an asset allocation for the portion of wealth to be used with systematic portfolio withdrawals.

Retirement Income Challenge

The Retirement Income challenge graphic above summarises the complexity of this issue. Retirees and their advisers consider how to best combine a variety of income tools to meet a broad set of goals and to manage the risks which jeopardise those goals.

Which type of retirement planning do you identify with?

Pfau and Cooper propose 6 key questions to help you gauge which retirement planning you more closely identify with.

Someone inclined to feel more comfortable with the safety-first approach (annuity) might provide answers such as:

Q1: How does stock market volatility affect your sleeping patterns?
A1: A lot.

Q2: Are you particularly fearful about outliving your assets or having to reduce spending dramatically at higher ages?
A2: Yes.

Q3: Is your standard of living (as distinct from annual spending amounts) vulnerable to a large market decline? In other words, do you have limited flexibility to reduce spending and still remain comfortable?
A3: Yes.

Q4: How funded is the retirement plan? Could you meet your goals without market risk, or is seeking upside integral to the success of the plan?
A4: Overfunded retirees could lock in their lifestyle and reduce worry.

Q5: Is it worth seeking greater upside potential when it exposes you to downside losses? How would you feel if your assets doubled in value? What if they lost half their value?
A5: No, the downside risk would be more devastating and not worth the risk.

Q6. How do bequest motives compare to spending goals?
A6: Meeting spending goals is more important than the bequest motive.

Naturally, opposite answers would suggest a person is more comfortable with more flexible and less guaranteed approaches.

If these questions have sparked a thought that you’d like to discuss with us, please either complete the contact form or give us a call on 01825 76 33 66.


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