Tony Hicks, Head of Sales at Copia Capital

For professional adviser use only

Planning for retirement has changed significantly over the past twenty years. We’ve seen a substantial rise in market-reliant defined contribution schemes, as opposed to final salary pensions, coming at a time when life expectancy has increased, and we’ve been given more choice in the products available at retirement through the pension freedoms reforms.

During these reforms, people were given the clear message that you no longer needed to buy an annuity, and therefore a secure income, in retirement. It also coincided with annuity rates operating at an all-time low, reducing the level of income that an annuity could provide from a retirement pot, making it an unpopular choice in retirement.

However, the sharp increase in interest rates in the past 18 months has had a knock-on effect in pushing up annuity rates. We’ve also seen considerable market volatility, which has negatively affected those drawing an income from their retirement portfolios. And we’ve had soaring inflation adding to the cost of living. Against this backdrop, some guaranteed income in retirement is starting to look a lot more attractive.

And I’m not just talking about old-style annuities. Innovative ways of using guaranteed income as an asset in conjunction with a purpose-built managed portfolio can help manage some of the specific risks clients face in the decumulation phase. In accumulation, the goal is to provide a real return and beat inflation, within the client’s risk appetite. In decumulation though, we need to consider longevity and sequencing risk and clients want more certainty of outcome.

The traditional approach of the 60/40 bond/equity portfolio has failed investors in decumulation in  recent history, due to the correlation of bonds and equities in falling markets. However, many advisers continue to use the same portfolio ranges for both objectives. There are real life examples of clients entering retirement and then immediately seeing 20% of their portfolios destroyed in the first year, fundamentally altering their retirement plans.

Scenarios like this are something the regulator is looking at very closely. Consumer Duty states that firms must “avoid causing foreseeable harm”, which we believe includes acting to ease the known risks facing retirees – sequencing, longevity, inflation and interest rate. And the upcoming FCA thematic review of retirement income advice could go even further. Because of the different risks involved, we hope that the review will recommend that a different investment approach be taken for those people approaching or already in retirement, compared to people in the accumulation phase.

We believe that, to address the specific risks people face in retirement, a portfolio purpose-built with decumulation in mind is required. And using guaranteed income assets as part of a decumulation portfolio can help mitigate some of these risks.

The guaranteed income is paid for the life of the client, it doesn’t fluctuate and is uncorrelated to the rest of the portfolio. It therefore has the benefit of giving clients who are in drawdown some protection against the effects of sequencing risk by reducing the need to sell their assets in unfavourable market conditions to generate an income.

Using this alongside a complimentary investment proposition means more of the client’s assets stay invested for longer and also allows more of the risk budget to be allocated to the investment proposition, providing an opportunity to outperform, without increasing the overall risk for the client.

Traditional annuities are seeing a resurgence of interest, but we think there’s a real opportunity to create innovative investment portfolios that use guaranteed income as an asset alongside other investments. That way retired clients can experience the advantages of a secure income, without giving up all the benefits of holding a diversified investment portfolio.

This article was first published in Professional Adviser on 11 August 2023. Please find a link to the original piece here.