Using structured products for retirement income streams
27 January 2016
Post Pension Freedoms, could structured products offer a viable alternative to drawdown and the fixed-term annuity/drawdown hybrids? Rob Kingsbury spoke to Colin Brockman of Investec Structured Products about the company’s recently launched Retirement Plans.
Markets conditions both in 2015 and to date in 2016 have highlighted the strengths of structured products in their ability to offer both positive returns and protection of capital against set percentage index falls, says Investec Structured Products’ Colin Brockman.
“Just looking at the FTSE 100, in 2015 we saw a 20% fall from high to low and the index ended the year 5% down. Like many other market commentators, we foresee more of the same for the coming year,” Brockman says. “Defensive structured products have worked well in these markets. The average return from the eight defensive Investec products maturing in 2015 was 15% over a two-year period, when the related indices on average over that same period delivered 2.03%.”
Brockman says there will be a similar focus for Investec on defensive products in 2016.
Greater need for income flexibility
Another interesting shift in the market, Brockman says, has been brought about by the new flexibility under the Pension Freedoms, creating a growing demand among advisory firms to find alternative income streams that fit with clients who have a more cautious approach to investing, while recognising that against low cash rates, investors need to take equity-style risk with their investments.
In response to this trend, Brockman says, Investec has designed a specific range of Retirement Plans that could be used as alternatives to fixed-term annuity and drawdown products.
“The first product we launched was the Retirement Deposit Plan. The Plan is a deposit-based investment that will deliver an income at a level that is similar to a fixed-term annuity but with upside advantages from being linked to an equity index,” Brockman says.
Investec looked at the fixed-term annuity market and saw that typically, over a 6-year period, fixed-term annuity products delivered an annual income but with a guaranteed minimum capital value of less than the investor had paid in.
“So we thought, why don’t we give people a chance to have all their capital back and get a similar income? We developed a product which is similar to a fixed term annuity but with a FTSE 100 kicker, if you like.”
Investec’s current product on the market offers two options: Option 1 gives 5% annual withdrawal from the deposit over 6 years, with 70% return of capital plus 30% if the FTSE 100 is higher than 90% of its level at the start of the investment period. Option 2 offers 4% annual withdrawal, and 76% back plus 24% if the FTSE 100 is above 75% of its starting level.
If the FTSE 100 is below the 90% and 75% barriers, respectively, then only the remaining capital deposit is returned.
Brockman says back testing over all the FTSE periods that could have been selected from 1984 to the present day, i.e. 6,566 tests, shows that the chance of this product receiving back the capital deposit plus the income paid out is 87.86% and 98.87% for Options 1 and 2 respectively. In addition, as a deposit, the capital falls under the FSCS to a limit of £75,000 per institution.
“The worst case scenario for the investor is that they will get back their capital deposit less the income they have received, compared to say a drawdown contract and even some third-way annuity products, which can expose capital to the full market falls unless the investor has bought the income or capital guarantees.”
He continues: “What we wanted to do was offer investors something different. Whereas third way products might combine a fixed-term annuity with a drawdown and allow the investor to top up the annuity income from the drawdown element, investors can do the same themselves using the Retirement Deposit Plan and a drawdown product of their choosing, topping up their income from the drawdown if needed, but with a decent certainty of getting all the capital back from the structured product at the end of the 6-year period.”
Brockman argues that structured products are particularly advantageous for retirees “when you compare the charges against hybrid solutions, which can include product charge, product guarantee and underlying fund charges” and the fact that structured product charges are already factored into the products pre-sale.
Using growth products and CGT allowance
Alongside the income generating Retirement Deposit Plan, the Investec Retirement range currently offers a FTSE 100 Defensive Growth Plan, aimed at investors with moderate risk outlooks. This offers 36% return if the FTSE is above 50% of its starting level after 6 years. This is on Investec Bank paper – an option exists for potential 28% return on non-Investec paper.
The initial investment is at risk if the FTSE 100 is down by 50% or more at the end of the 6 years. Back testing on performance of the FTSE periods that could have been selected from 1984 to present shows that in 6566 tests the chance of the investor receiving back the full capital plus the 36% return is 100%, Brockman points out.
“Using the Growth Plan with capital gains tax allowances, on maturity, the capital growth sum can be used to deliver an income stream,” Brockman says.
“Both these products we believe offer a good opportunity for investors in retirement, particularly where we are experiencing volatile and choppy markets.”
Defined benefit (DB) transfers remain topical and the Financial Conduct Authority (FCA) continue to find problems in this market....
A recent decision by the FOS to uphold a complaint against Intrinsic Financial Planning highlights several issues with how...
ATEB Consulting’s Steve Bailey looks at what is expected when the latest rules on pensions transfers come in on...