Capacity for Loss in Retirement: a possible process

For financial professionals only

When we talk about the possibility of loss in retirement, things get pretty complicated.

It’s so much simpler with a long-term savings goal. You want maximum growth and control over the amount of volatility you experience to avoid disappointment at your target date, and minimal anxiety along the way.

But when a portfolio is supporting a retirement lifestyle, you need it to cope with sequence risk, inflation, declining investor capability whilst offering good value against the competition from guaranteed products. So, ‘loss’ has a more generalised meaning.

Risk in retirement

The key risk in retirement is that your assets cannot sustain your lifestyle. So, the level of certainty you’ve achieved around your potential income relative to your spending pattern is important. As is knowing your need for certainty in each successive tier of income, from covering the basics to splashing out on the little luxuries to have capital for bequests. And there’s knowing how readily you would sacrifice spending in each tier – in order to protect your long-term position.

Measurement is not enough

What we’ve seen from the regulator in CP20-15 is guidance which makes it clear that doing some sums around this problem isn’t enough. The client must be happy with what’s being proposed to them. And people are so different. A millionaire who hated investment risk would be happiest with an annuity. A retired adviser with strong budgeting skills, experience and interest in investing might be happy taking in drawdown whatever the market gave him last year, or in bad years, 4% and be happy to invest at Risk Grade 7, with no underpin.

A possible process: looking at ratios

Here’s a picture of how measurement and assessment of client income could inform a planning process and achieve a capacity for loss at the appropriate level.

Pigraph 1

What might these suggestions mean for someone retiring on a salary of £60,000?

Pigraph 2

To meet their guaranteed income goal, this individual needs £16,500 of annuity income. Then, to meet their target income goal, they need a further £17,500 of income from drawdown. Fortunately, they have been well advised to save and with £850,000 in SIPP the sums are likely to work out, with say £400,000 invested in guaranteed income and £450,000 invested in drawdown.

How to test for achieving a minimum income

You can test for the certainty of achieving minimum income using Parmenion’s Income Manager Tool (IMT). In this example, the minimum income level is £7,500 out of the total drawdown income target of £17,500. You can find the probability of being able to buy that much secure income after say, 10 years withdrawing at the higher level of £17,500 in a separate ‘what if’ analysis. That means you know the risk of not achieving the minimum. If you like those odds, the sums add up and the client is comfortable taking their chances, it looks like things are set up well for the medium term.

Hear what the experts think in Episode 6 of our Let’s talk retirement series

Thu, Aug 13, 2020 11:00 AM

In episode 6, I chat with Karen Brolly, Head of Products at Hymans Robertson and Carla Langley, Business Risk Consultant at threesixty.

They share respective insights on how to model the severity of possible downsides, and the mistakes made in advice firms when assessing a client’s capacity for loss.

Watch the replay ➜

This article is for financial professionals only. Any information contained within is of a general nature and should not be construed as a form of personal recommendation or financial advice. Nor is the information to be considered an offer or solicitation to deal in any financial instrument or to engage in any investment service or activity. Parmenion accepts no duty of care or liability for loss arising from any person acting, or refraining from acting, as a result of any information contained within this article. All investment carries risk. The value of investments, and the income from them, can go down as well as up and investors may get back less than they put in. Past performance is not a reliable indicator of future returns.  

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