In the wake of recent market volatility, it may sound strange to criticise de-risking clients’ pension savings as they approach retirement. But as large numbers of clients run the risk of inadvertently locking in market losses, Andrew Tully, Technical Director at Canada Life, discusses why there has never been a better time to highlight the importance of reviewing client investment strategies as they approach retirement.
Traditional convention has always been for clients to de-risk their pension savings in advance of retirement by moving them into less risky assets. As a result, many defined contribution (DC) schemes are set up on that basis and clients are automatically moved into cash and bonds in the lead up to standard retirement age.
An outdated approach puts clients at risk
At the time, these strategies were well intended. Most people assumed they would buy an annuity at retirement, so they wanted to avoid losing money shortly before they retired. Any sustained losses would have a direct impact on the amount of income they would receive, with no chance of recovery. But times have changed. Three times as many people use drawdown as buy an annuity, indicating that in most cases it makes more sense to remain invested.
Recent market volatility has made this approach even more important. While a handful of pension customers may have been lucky and moved into less risky assets just before the market crashed, many will have inadvertently de-risked their savings since then, thus locking in those losses.
The point is that no client – whether advised or non-advised – should be blindly changing their investment strategy without consideration of the prevailing market conditions and their current investment objectives. Especially just before, or in the early stages of retirement.
Investing for retirement
So, assuming all clients arrive at retirement with a mixed portfolio of investments, what should their strategy be for the years ahead? Clearly that depends on their individual circumstances, such as how much income they need, their health, the amount of savings they have, and to what extent they have other assets to fall back on.
As the table below shows, investing in retirement is different to investing for retirement. Retirees don’t know how long they will need to remain invested (because they don’t know how long they will live), they don’t know how much income they will need and when – especially in 5 to 10 years’ time, and they don’t know the future impact of inflation.
The reality is that there is no best way of organising a pension fund for decumulation. It really comes down to an individual’s needs and objectives. For most clients though, a combination of guaranteed income and the flexibility which drawdown offers is likely to give the best solution. The recent crisis has highlighted the need to guarantee a portion of income to cover essential expenses (in addition to the State Pension and any defined benefit income), yet the importance of being able to grow income in line with inflation remains paramount.
Indeed, inflation poses an even greater potential threat to retirees in the wake of Covid-19. Rising inflation is a possible repercussion of keeping interest rates artificially low, while the government is forced to spend more than they are taking in taxes. Only time will tell, but an uncertain economic future underlines the need for some income certainty alongside flexibility.
Of course, the recent market crash will do nothing for client confidence and many may believe the logical thing to do is to de-risk and protect their savings. But for those who have suffered heavy losses to their pension savings in recent weeks, it remains even more important to stay invested, be patient, and remember that their investment horizon could stretch well into retirement.
For clients with a nervous and risk-averse disposition, phased annuitisation could be a good solution. The Canada Life Retirement Account enables clients to approach annuitisation in multiple stages, depending on the amount of pension savings they have and how their income and lump sum requirements unfold as they make their way through retirement. They will have the means to remain invested and manage their changing income needs throughout their retirement as cost effectively, tax efficiently, and as hassle-free as possible, while also de-risking their portfolio over time by guaranteeing an income to cover basic expenses.
Canada Life Limited is authorised by the Prudential Regulation Authority and regulated by the Financial Conduct Authority and the Prudential Regulation Authority. Registered in England and Wales no. 973271. Registered office: Canada Life Place, Potters Bar, Hertfordshire EN6 5BA. MGM Advantage Life Limited, trading as Canada Life, is a subsidiary of The Canada Life Group (UK) Limited, and is authorised by the Prudential Regulation Authority and regulated by the Financial Conduct Authority and the Prudential Regulation Authority. Registered in England and Wales no. 8395855. Registered office: 6th Floor, 110 Cannon Street, London EC4N 6EU.