Use of drawdown modelling increases over fixed rate method

10 June 2021

Modelling tools have overtaken fixed rate methods when advising on income drawdown, new research from Aegon has shown.

Nearly two fifths (38%) of advisers now use modelling tools to determine sustainability of retirement income, up from 28% in 2020.

In contrast, use of fixed rate or range method has fallen from 41% to 37% over the last year and for those advisers who do use it, there has been a big increase in using a rate of less than 4%.

According to Aegon, advisers relied on modelling tools during the pandemic to illustrate portfolios and analyse scenarios after markets fell sharply at the end of the first quarter 2020. The fixed rate method can be more inconsistent with cashflow modelling, particularly during periods of volatility or for clients with irregular income needs, the retirement specialist said.

Other methods including basing income on annuity rates or taking portfolio income have also fallen in popularity over the past year amid a challenging interest rate environment.

Steven Cameron, pensions director at Aegon, said: “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% 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.”

The research also showed a divide among advisers on whether clients have taken more or less tax-free cash at the point of retirement over the last three years. Nearly a quarter (23%) said clients had taken more, while the same number agreed it had been less. However, the majority of advisers (79%) were agreed that “drip-feed drawdown” – where pension proceeds are vested in stages – is the top reason for clients taking less tax-free lump sum immediately at retirement.

Cameron added: “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% 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.

“Pension providers have facilitated phased withdrawals through drip-feed drawdown products, allowing advisers to structure flexible withdrawals for their clients through 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.”

Professional Paraplanner