Cashflow modelling – why we think it’s key
11 October 2018
The retirement income world has changed, throwing financial planning a few curved balls, says Jamie Evans, business development manager, Seven Investment Management
Three years ago, planning for your client’s retirement got a lot more interesting, but also more difficult. Pension freedoms meant that annuities no longer needed to be the only choice for most clients. That was the right decision for many clients, because while annuities deliver guaranteed income throughout your clients’ life, the income is much lower than levels in the past. Having dropped after the Global Financial Crisis, they fell to an even lower level in September 2016 and, despite increasing for a second successive year, are still not delivering a decent income.
Meanwhile, many financial planning firms saw pension freedoms as a golden business opportunity. Given pensions can be handed on to beneficiaries outside of the estate for inheritance tax purposes, there’s an opportunity for you to help clients who won’t necessarily need all of their investments and savings. And, as you help them to pass on their estate to the next generation, you have the chance to get in front of that latest generation too. That could mean you increase the likelihood of keeping more family members as clients over the long term.
While there’s no specific figure for the UK, research from the US Investment News publication suggested that about two-thirds of children sack their parents’ financial adviser after they’ve received any inheritance. Meanwhile, just 13% of the advisers surveyed ranked generational wealth transfer as a business risk. It’s not much of a stretch to believe that the numbers will be quite similar here in the UK.
Pension freedoms also throw advisers a second curve ball – clients might run out of money years before they die. The FCA recently flagged that the average annual percentages that clients draw down had gone up to 5.9%, from 4.7%. Meanwhile, pension pots of less than £100,000 most often saw withdrawal rates of more than 8%. If your client withdraws 8% from a pot worth £100,000 in the first year and then continues to withdraw the same level of money (£9,520) every year (but they have only invested their money to deliver a 3% return on an annualised basis), they’re going to run out of money in the 11th year.
These levels of drawdown are hardly a surprise. With bonds not delivering the typical level of income that they have for previous generations of retired (and therefore naturally cautious) investors, and with inflation now at 2.7% (as at the time of writing), people are going to want to withdraw more of their pot to maintain their standard of living. But how do they know when they’ll be withdrawing too much in advance?
This is precisely why we believe that cash flow modelling is key. How else can you show a client the impact of withdrawing a larger sum? Other tools exist, but our app, 7IMagine, is free. We also linked its My Future planning capability to Intelliflo’s Intelligent Office. And we made the tool as engaging as we could. Clients can see for themselves the consequences of what might seem to be a small decision, but one that could compound up to have very big and very serious implications.
We are confident that you don’t want your clients to run out of money in the future. And while the FCA held back on requiring that cashflow modelling be mandatory for retirement planning after a recent round of industry consultation, we believe it’s a vital exercise. It’s also one that, done properly, will set you apart from some of your peers.
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