Pensions - Articles - Modelling tools overtake fix rate methods on safe drawdown


Research from Aegon shows, that when it comes to retirement income, advisers are moving away from using a fixed rate method to determine a ‘safe’ withdrawal rate towards modelling tools, which have become more valuable than ever during the pandemic. The research also shows a continued move to using drip-feed drawdown, meaning some individuals are taking less of their tax-free cash immediately at retirement, although the picture is mixed.

 Modelling tools, such as cash flow planning and scenario analysis tools are, for the first time in Aegon’s research, the preferred method used to determine sustainability of retirement income. 38% of advisers now use modelling tools, an increase from 28% in 2020. By contrast, use of fixed rate or range method has fallen from 41% to 37% over the last year and where it is used, there has been a big increase in using a rate of less than 4% (32% compared to 21% a year ago).

 Modelling tools facilitate a more dynamic approach to managing retirement income and advisers said they have relied on these more than ever over the last year to illustrate portfolios and analyse scenarios after markets fell sharply at the end of Q1 2020. The fixed rate method, on the other hand, can be inconsistent with cashflow modelling, particularly if clients have irregular income needs or during a period of volatility.

 

 Other methods, such as basing income on annuity rates or simply taking portfolio income, have also fallen in popularity, with advisers citing the continuing challenging interest rate environment.

 Steven Cameron, Pensions Director at Aegon, comments on withdrawal strategies: “The rate at which you withdraw income in retirement is a crucial consideration and advisers look to strike a balance between meeting clients’ current objectives while ensuring they have enough money to maintain an income throughout their life. The research highlights that for the first time more advisers are using modelling tools over a fixed rate to determine a ‘safe’ withdrawal rate.

 “Historically, it was common to base a fixed rate on the 4% rule of thumb for those with regular income needs, but advisers are increasingly considering whether adhering to this strategy is the best approach, particularly in volatile markets. Modelling tools allow for a more dynamic way to manage a sustainable income and will have been heavily relied upon during the market downturn at the onset of the Covid-19 pandemic. Furthermore, where a fixed rate approach is taken, there has been a big increase in advisers using a rate below 4%.”

 Taking tax-free cash at retirement
 Advisers have a key role to play in helping individuals make the most of their 25% tax-free lump sum entitlement from DC pensions, including avoiding the full amount being taken immediately as default.

 The research shows that advisers are split on whether clients have taken more or less tax-free cash at the point of retirement over the last three years, with 23% saying less and the same proportion saying more. The majority of advisers (79%) said drip-feed drawdown is the top reason for clients taking less tax-free lump sum ‘immediately’ at retirement. This is where pension proceeds are vested in stages with a combination of drawdown income and tax-free cash providing the desired income in the most tax efficient way.

 Another popular reason for deferring taking a tax-free lump sum at retirement is that it can
 remain invested tax efficiently and potentially provide a higher value of tax-free cash later in retirement.

 

 Steven Cameron, Pensions Director at Aegon, comments on use of tax-free cash: “Since the pension freedoms, people have been offered greater flexibility in how and when they access cash from their retirement savings, and using income drawdown continues to rise in popularity. Advisers have a key role to play in helping individuals use their DC pensions to generate an income in the most tax efficient way. The prospect of being able to take 25% of the full pot as a tax-free lump sum immediately on retirement may look like the obvious choice, but there can be good reasons for taking less immediately and instead, phasing this.

 “Pensions providers have facilitated phased withdrawals through drip-feed drawdown products, allowing advisers to structure flexible withdrawals for their clients though a mixture of tax-free cash and taxable income in a way that best suits their clients’ tax position.

 “The research shows advisers are split on whether people have taken more or less tax-free cash at the point of retirement over the last few years but where they have taken less, use of drip-feed drawdown was the driving force.”
  

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