Articles - Hard choices in 2021

Where 2020 was largely about sitting tight and not panicking, in 2021 we need to get back to looking at long term returns. Unfortunately for pension savers the outlook has changed significantly from pre-COVID days and they may find themselves in unaccustomed territory. Over the last few years our pension clients have been fortunate to have seen some very positive investment returns, often in excess of the projected amounts.

 By Fiona Tait, Technical Director, Intelligent Pensions

  As a result, annual reviews have been upbeat and despite warnings that this could not last for ever, it has been relatively easy to demonstrate the value of our advice.

 In 2021 the consensus view is that long term returns are likely to be significantly lower as both economic growth and corporate earnings remain depressed. As this view is coming to us from a number of different asset managers it must be considered realistic and we have to factor this into our advice. Our firm has therefore taken the decision to revise the investment assumptions used in our cashflow modelling meaning that some clients who have previously been told that their plans were comfortably on track may be hearing different – and unwelcome – news at their next review.

 This is particularly difficult for clients who are already taking income and may no longer be able to justify the same level of withdrawals, but it also affects accumulation clients who may find themselves having to save more or revise their retirement objectives.

 Drawdown sustainability
 We know already that under our new projections some clients will still be able to meet their objectives, some will have to make slight adjustments to their plan, and some will unfortunately find that their pension simply cannot continue to support the level of income they want to take.

 No client likes to be told that they need to reduce their spending, especially if they have always managed to keep on track before, yet it is sometimes necessary for good financial advisers to say things that they know their clients don’t want to hear.

 The obvious solution for a drawdown plan which is no longer predicted to be sustainable is to reduce income withdrawals, and where clients can do this that is what we will advise them to do. In reality however many of these clients are likely to have existing commitments which they need to meet and immediately reducing income is not a viable course of action. So what else can be done?

 Firstly, we can look at other assets. A surprising number of clients still hold significant cash reserves even though they are taking money from their pension. A sensible strategy would be to reduce the pension withdrawals and top up with ‘rainy day’ money – this must after all be considered a fairly inclement period for our finances. Top of the list of alternate assets would be money held within cash ISAs or short-term deposit accounts. Longer term deposit account could be used to support income later in the year and other investments could also be used depending on the tax treatment and any timing constraints. In more serious cases it may be time to consider accessing equity from the home, either via downsizing or using equity release.

 The other main alternative is to revise the investment strategy. Clients with existing capacity for loss may be prepared to increase equity exposure in order to boost potential growth. This is not something that should be done lightly and it is important to take the client’s current attitude to risk into account but this may be acceptable for those with a relatively long term left in retirement during which the potentially greater downside could be ridden out over time.

 There is of course a way in which to make a higher risk strategy more palatable – by creating a secure income underpin. We still encounter considerable client resistance to annuities however if essential income is covered via partial annuitisation it does provide more scope for the remainder of the portfolio to be invested for growth. Modern retirement products allow clients to hold both an annuity and drawdown within the same plan, and in the case of the Secure Lifetime Income product from JUST the income which is actually withdrawn can still be varied as required.

 Tempting as it might be, we cannot avoid giving bad news when it occurs and we cannot breeze past it in the hope that things will somehow get better. It is certainly possible that actual investment returns will be better than the ones we are now forecasting but it would be inadvisable to rely on this.

 Staying on track for a sustainable retirement makes it less likely that even bigger and harder decisions may have to be made later on.

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