Sequence Risk – Pensions
I’m playing all the right notes – but not necessarily in the right order — Eric Morecambe
Pension freedoms have been with us for some months now. Despite criticism of Pension Wise guidance and the efficacy of the publicity on the run up to 6th April, it is clear that people now understand that when they attain 55, they have a lot of options in front of them. I see plenty of prospective clients who need a bit of a sounding board. When everything is possible, how on earth does one decide on the best course of action?
In recent years, investors have been worried – sometimes to the to the point of paranoia – about institutional risk, inflation risk, interest rate risk, liquidity risk, and even currency risk and political risk…it makes the seemingly benign question we ask ‘how would you rate your attitude to risk?’ terribly difficult to fathom, and even harder to answer.
Compounding the problem, and as a direct consequence of the new rules around pensions, the new kid on the block here is sequence risk; meaning the order in which assets are used to derive income or capital.
Historically, clients would access their PCLS (tax-fee cash to the layman) then use the remainder of the pot to purchase some form of taxable income. Many people ran down the pension pot to preserve that which could be bequeathed without a tax hit. It was good advice at the time.
Nowadays, we extol the virtues of leaving a pension alone if at all possible, often making it the LAST asset to provide any bolster to income requirements. The cash flow models we run for our clients can show a huge long term effect on the financial position, simply through altering the sequence of events when entering the decumulation phase (AKA spending your money!).
Moving from ’strip it bare’ to ‘leave it alone’ is a clearly a pretty major shift in the shape of our advice. Investors who have been ‘retired’ for more than a couple of years, in receipt of non-earned incomes, certainly have a question to ask their advisers.