Monday, 29 October 2012

What is RDR – EU Gender Directive for Pensions and Annuities?

RDR for me is many things but it fails on one level, and that is the possibility that individuals will need to make their own way in a complex market. Imagine if electricians or plumbers no longer would call to your house for work under £1,000. You would turn to friends or do it yourself. In some cases this would work in others it would be a mess.

The EU Gender Directive is an example of this. I had a friend how contacted me because his solicitor told him to buy an annuity because his annuity rate would drop by up 10% if he did not buy before December. I have also seen direct sites stating similar values. Of course this creates fear, fear then creates a herd mentality and eventually panic buying.

Education or financial planning is about cutting through the noise. Let’s say your financial plan is in place and you are currently receiving your income from a number of sources including pension drawdown what do you do?

Let’s look at the facts?

What is the Gender Directive?

Basically from 21st December it will not normally be lawful to offer individuals different annuity rates for males and females. This means they must be written on unisex terms.

What this means is that providers have assumed males generally have shorter life expectancies than females. For this reason males get better rates than females, however now they must have the same rate.

How will this impact on annuity rates?

In reality it is likely providers will blend their male and female rates. So this means rates will fall somewhere between their current male and female rates. How this sits will depend between providers.

Currently annuity rates for men are around 5% - 8% better than females. Early indications seem to show that providers will move closer to the current female rates and then move to a mid-ground at some point in the future.

The biggest impact appears to be around where an individual is buying a pension with no spouses pension however where there is a joint annuity the change is not so dramatic. The tables below provide an example (although not guaranteed):

Joint Life Basis (50% spouses, £50,000 premium)

Client age
Male / Female
Female / Male
1% - 2%
1% - 3%
2% - 5%

Single Life Basis (£50,000 premium)

Client age
4% - 5%
8% - 10%

How will this impact on pension drawdown?

Interestingly the current rules from the HMRC are that the both males and females will use the male rates. This means that for males there will be no change but for females this could see an increase in income.

So for example a female age 60 with £50,000 premium and 2.25% gilt rate would receive £2,250 p.a. From December this will go up to £2,400. An increase of over 6%.

It could be this is a limited opportunity but we will have to wait and see.

So what do you do?

This comes back to financial planning. If you have a plan and that plan indicates that drawdown is one of the sources of income then the question is whether anything has changed to that plan to make you move to buying an annuity? My argument is this it is very easy with all the noise, and marketing material to panic and run with the herd. But if nothing has changed, and you can still deliver on the plan then walk away from the herd.

What is RDR – the changing face of retirement?

RDR is a big topic for the papers, I can easily get hung up around what they say and how it doesn’t seem to paint a full picture, or I could focus on the challenges we are facing.

I am in favour of RDR as a concept; however the real underlying problem is that of getting people to engage with their money. Whether this is through an adviser, or whether going direct and doing it yourself. In the next two blogs I want to explore firstly the changing face of retirement and then I want to look at the Gender Directive for Pensions and Annuities.

One area I keep focusing on is financial education. Some of us may be lucky and have what was called a final salary pension scheme. This effectively provided us with a guaranteed pension based on the years of service we did and the earnings we received. So say I was earning £10,000 when I retired and worked for 40 years I might get 50% of that as a pension for life.

The responsibility for that rested with the employer, and in some cases still does. The problem is that these schemes are too expensive to run. There are a number of factors behind this but life expectancy has to be a crucial element to this. We are living longer and it means to provide any guaranteed income in retirement is expensive for the employer.

So we are now seeing a shift to a position where the individual and not the company takes responsibility for ensuring they have sufficient income in retirement. The problem you have as is highlighted by many articles on RDR is that those just starting out are being priced out of the advised market. So what I mean is someone wanting to get advice on where to start has no-one to turn to.

This heightens a growing fear about what will happen when we reach retirement. Not immediately but for many who spend years saving to buy a house, then having children and then eventually considering retirement feel they are too late to do anything and can find no-one to help.

A recent survey indicated that 67% of those surveyed felt that their workplace pension was central to providing their income in retirement. However, longevity, low interest rates and other factors have driven down annuity rates so we need to save more to get what we want. In fact this survey indicates that very few individuals expect to use non-retirement plan assets to fund retirement.

So we are starting to get a divide where people are still holding onto the idea that the employer will provide when in reality the individual needs to accept this responsibility.

We have seen auto-enrolment and NEST. I did a lot of research into this and perhaps it has changed but there were a number of areas that concerned me. Firstly the funds were limited to one provider and a smaller number of tracker funds, secondly the pension was not portable, thirdly the contribution limits had a ceiling and finally there was no advice.

Where is this leading we are coming into a generation of new retirement saving, which includes volatility in the world of investments, no risk-free investments and now limited access to advice. The crucial point is that young people are not engaging with retirement planning because they have other priorities and actually by not engaging this will have a huge impact on the type of retirement they can expect to enjoy.

Whilst journalists have a field day at how nasty financial advisers are they are missing a time bomb. The need to help individuals in financial planning and in fact a responsibility to take this on; we live in a new era which people have not accepted. RDR is good for a number of reasons, it fully discloses fees and it makes a more professional industry however there is a danger that it provides no scope to give advice or information to those starting out who really need it.

And of course providing in retirement is not just about using a pension, you could have a buy-to-let property, you could use tax free income from an ISA, you could use CGT allowances etc.

So where do we go – I am convinced that someone will develop a structure to provide low end advice, however we also need to develop an un-bias information portal which provides all forms of financial education from basic budgeting to goal setting. Journalists and other interested parties should help to promote this and together we can start to fill the gap that is being left.

Wednesday, 24 October 2012

What is RDR - Financial Planning – Part 2

In my last blog I explored the arguments around having a financial plan and in particular looking at cash and how this may no longer be the right place to be.

The next aspect I want to consider is income in retirement, we read different arguments around whether we should opt for an annuity or take drawdown. I want to turn this on its head.

Three years ago a fund of £800,000 would provide a 65 year male with a pension of £50,000 a year this included a two thirds spouse’s pension and was guaranteed for five years. Now they would need a fund of nearly £1,000,000.

I won't go into drawdown but this has also had a massive dent because of changes in the rules and falling annuity rates.

The problem is that once again we are fixated on the solution and not the goals. Because people see this they say pensions are dead, and why would you invest in a pension for 40 years to find that you can’t get your money out. Of course there are some positive aspects to pensions but let’s ignore those for this blog.

This goes back to financial planning. When we draw up a plan we identify goals. I recently reviewed my financial plan after finding myself out of work twice in the last three years, and having to use most of our savings to survive we only have a small amount of savings. We have set up three goals – two are short term goals but I want to focus on the third, retirement planning.

In drawing up the plan I considered what we could live on in retirement, this looked at our current budget and what elements would not be there when we retire – so for example the mortgage, life assurance etc.

We then looked at what we had, so we will have a state pension (hopefully), some guaranteed pensions and some personal pensions. We have estimated that all of this will give us a comfortable foundation stone in retirement. However, this is short of what we need. The next step was to consider the most tax efficient way to receive the remaining income. In our case we have opted to save into an ISA because the fund is tax efficient and the income is tax free. We except that the downside is that we don’t get tax relief on contributions and that it will form part of estate but it fits with our plans.

Turning to investments we have taken a more adventurous approach to investing, looking to invest across a number of sectors and geographical regions. We also hold a small number of shares.

And finally we monitor the plan quarterly and fully review on an annual basis. The point of financial planning is this, if we focus (as the headlines do) on the end solution then we can lose sight of the goals. If we focus on the goals then we can tweak the end solution to ensure it continues to deliver. 

Disclaimer: This is just an example, other solutions may be appropriate depending on an individuals circumstances. 

What is RDR - Financial Planning – Part 1

Central to RDR has been the aim of raising the professional standards of investment advisers, giving consumers greater confidence in the advice being offered. 

Although journalists are keen to focus on fees one aspect they seem to be missing is the importance of financial planning. In the next next two blogs I want to explore this further, and why it matters.

One of the most important aspects of investing is planning. As I have argued before in blogs you don’t approach a DIY job without putting in place a plan and ensuring you have all the tools to deliver on the project.

Whether you go down the DIY route or whether you seek financial advice the crucial aspect is planning.

In this first blog I want to focus on the fixation we continue to have on cash savings. There are two aspects to this, firstly we perceive cash to be safe and secondly in retirement cash has been seen as a source of income.

In 1999 the average cash ISA was paying 6% a year. So the argument around an income seems a strong one. So if I had £100,000 then I would receive around £6,000 in interest payments. However, the average cash ISA is now paying less than 1% a year. If I continue to take £6,000 a year not only am I losing out to inflation but with no growth I am quickly eroding my savings base.

Even if I don’t take any income £100,000 invested in cash in 2012 could see its value fall by 17% over the next 10 years. This is based on an interest rate of 0.8% and inflation of 2.6%.

Another aspect to consider is that if the cash is being used in retirement we are living longer, for many 20 years of retirement is not unheard of. To hold money in cash for 20 years will have a material impact on retirement income.

So how does this apply to financial planning? I recently searched for retirement income; I came up with a number of solutions from direct platforms – structured products, corporate bonds, investment funds etc. Many promising income of 5% p.a. plus. This all seems really appealing but there is a risk with all of these investments and how much do we understand that risk.

Financial planning starts with looking at what your goals are and then working down to the solution. So let’s consider someone with £100,000 and wanting to provide an income.

Financial planning will start with what income the person wants, and what they have to deliver that income. So for example someone might want £1,500 NET a month. They have a state pension paying £800 GROSS per month, perhaps some pension income paying £500 GROSS per month. So the net income is around £1,200 per month. This means they need around £300 a month from the investments.

The next step is then to consider how to provide sustainable long term income; this is about understanding a client’s attitude to risk. Most clients in retirement will say they are cautious or even defensive but if you tell them that their investments will erode whilst in cash they start to worry. Carefully constructed portfolios can deliver returns over the long term in excess of cash and inflation. There will be an element of volatility but it enables clients to receive income and growth.

Once you start to build a plan around the investments then you can consider the most tax efficient wrapper, this could be an ISA which provides a tax free income, or it can be held outside of an ISA where you use your CGT allowance.

So a financial plan is about building a whole picture. We no longer live in a risk free world, and whether you decide to go direct or go to a financial planner you need to consider what your plan is. RDR will make charges more transparent but ultimately if we don’t understand the concept of a financial plan then no amount of changes to our industry will help in our attitude to investing. 

Disclaimer: This is just an example, other solutions may be appropriate depending on an individuals circumstances.