Advisers are embracing modelling tools to calculate ‘safe’ drawdown withdrawal rates in preference of older fixed rate methods according to new research.
Aegon found that around 38 per cent of advisers now use these modelling tools — an increase from the 28 per cent using them a year ago. This is the first time that these tools are now the preferred method used to determine sustainability of retirement income.
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.
By contrast, use of fixed rate or range method has fallen from 41 per cent to 37 per cent over the last year and where it is used, there has been a big increase in using a rate of less than 4 per cent (32 per cent compared to 21 per cent a year ago).
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.
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.
Aegon pensions director Steven Cameron says: “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 per cent 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 per cent.”
Advisers also have a key role to play in helping individuals make the most of their 25 per cent 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 per cent saying less and the same proportion saying more.
The majority of advisers (79 per cent) 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.
Cameron adds: “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 per cent 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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