Retirement income: why smoothed funds and why now?

Has the recent market volatility along with significant regulatory change prompted some difficult conversations about retirement income with your clients? We take a brief look at the current environment and consider how a smoothed fund could help you meet the retirement planning challenges it creates.

In the past three years, we’ve seen share prices fall sharply as a result of the pandemic, recover, then waver in response to various geopolitical events that led to higher interest rates, soaring inflation, and a cost-of-living crisis. We’re also entering a time of political uncertainty, with the recent general election in the UK, Emmanuel Macron’s call for a snap poll in France and the Presidential election in the US.

For those clients taking, or who are in the run-up to taking, a retirement income, volatility is an important topic. It could change not only how they view risk, but also how they want to structure their portfolio or time their decisions. For example, if the market drops suddenly, someone invested in traditionally structured funds might want to try to recoup losses before taking an income – if they can afford to wait. If they can’t, the alternative would be locking in losses from the decline. 

Adapting to a new lifestyle

Situations like these are more likely to arise when there have been no plans in place to ‘de-risk’ the client’s portfolio in the lead up to taking an income. But with some clients choosing to remain invested to, and through, retirement, how can you help them to reduce portfolio risk while still benefiting from drawdown flexibility?

As well as market uncertainty, regulatory change could also be having an impact on your conversations with clients. There’s the Financial Conduct Authority’s (FCA’s) new consumer duty rules, which it has said would lead to a “paradigm shift” in how it expects financial services firms to operate in retail markets.¹ Then there’s the FCA’s Retirement Income Advice Review, which recommends that advisers have robust processes for clients in, and approaching, decumulation. This includes knowing:

• how income needs to be structured;
• whether it meets the client’s needs; and
• if the withdrawal rate is sustainable – are they likely to run out of money?

Smoothing the journey to retirement

So how can smoothed funds help advisers plan according to a client’s risk tolerance, desire for growth, income needs and flexibility requirements? Let’s consider the accumulation phase first.

Here, a smoothed fund could be worthy of consideration for those who have previously been able to accept market risk but are soon to reach retirement. For these clients, a smoothed fund could offer the potential for higher returns compared to the traditional methods of de-risking a non-smoothed portfolio. A smoothed fund could also be a useful tool for your more risk-averse clients who still want to participate in any long-term market growth. The smoothing mechanism can help them do this, without being exposed to the extremes of day-to-day volatility.

A gentler transition

You might also consider a smoothed fund for clients in need of a blended investment solution that targets income and growth. For someone in the run-up to retirement, a partial allocation to a smoothed fund could provide an element of defence in the event of the market falling sharply, without sacrificing the potential for growth over the long term.

Fewer bumps in the road through to retirement

When a client starts to withdraw from their pension savings is when sequencing risk comes into play. For a client who remains invested in retirement, this is the risk that an early withdrawal or withdrawals coincides with a sharp market downturn. In short, it means a greater number of units need to be encashed to provide the client’s required income, which has negative effects for their fund value over the long term. Smoothing can help by providing more stability for the fund value while the client takes an income. Below, we consider how this might look in more detail, using the ‘bucket approach” to planning for withdrawals.

Buckets of income?

We know that advisers use many different strategies to address their clients’ income needs in retirement, but the bucket approach is one that has come up often in our recent discussions.

This involves placing retirement assets into three buckets: Today, Tomorrow and Future. In each one, investments involve different levels of risk, depending on the client’s risk profile, behavioural capacity, timeframe and need for money.

The bucket approach can help to reduce sequencing risk, since the “Today” bucket is likely to hold lower-risk, more liquid holdings. These are designed to meet income needs without withdrawing from capital market-backed investments while a downturn is occurring.

In contrast, assets in the “Future” bucket have a longer time to recover if they drop in value, which means it can typically carry more market risk, with the assets inside it focusing on long-term growth. 

The second bucket, “Tomorrow”, could be the most natural home for smoothed funds in this type of income withdrawal strategy. That’s because this bucket has dual aims – protecting tomorrow’s money, but not missing out on long-term growth.

It’s clear that smoothed funds can play an important role in a variety of strategies and at various points in a client’s journey to, and through, retirement. Whichever way you decide to use them in your clients’ retirement income planning, it’s useful to have convenient access.

The Standard Life Smoothed Return Pension Fund is now available exclusively on the Fidelity Adviser Solutions platform. More information about this smoothed fund is available here.

¹ Source: A new Consumer Duty, FCA May 2021

Money invested is at risk.