Retirement Income

A plan for addressing clients' volatility concerns

7 min read


12 Mar, 2020

Recent market volatility has, for some clients, changed their expectations of retirement. For some, expectations of retirement just got a little scarier… a little less certain.

Advisers tell us that during times like these it makes sense to have a plan for addressing clients’ volatility concerns, both proactively and in response to concerns as they arise. A plan that, when implemented, actively reduces clients’ concerns in uncertain times.

What follows is a consolidation of ideas from advisers who, over time, have been happy to share how they address clients’ concerns in times of volatility, or, a plan for addressing clients’ volatility concerns.

Remind clients that you are there, that you are aware and that you care

This first idea is a simple one, and will sound obvious, but comes up (in a variety of forms) frequently in conversations with advisers about dealing with clients in uncertain times: Remind clients that you are there, that you are aware and that you care.

We know that clients who have received advice in the past 12-months worry less about outliving their savings and investments than those who haven’t received advice1. A quick phone call or an email will, for some clients, represent an appropriate and timely reassurance of your advice, reaffirming the confidence that comes from an implemented retirement plan. For other clients, a sit-down, face to face or the opportunity to bring forward a regular review might be the assurance they require.  

It also makes sense that if you are communicating with clients to make it about them. Yes, you’re aware of volatility, but, much more importantly, you’re aware of what volatility means to your individual client and their retirement plans.

And, finally, showing that you care isn’t about a hug or a shoulder to cry on (well, perhaps sometimes it can be!). Yes, this is about empathy, but also about the opportunity to demonstrate your continued professional interest and commitment to ensuring clients are as well positioned as possible to face the significant challenges that volatility and uncertainty present to retirement plans.

Reconfirm client risk tolerance

For some clients, the theoretical concepts of volatility, market risk and sequencing risk all just got very, very real.

It is perhaps reasonable to expect that, even considering the robustness of many risk profiling techniques used by advisers, some clients will have a different tolerance to risk when determined during a period of strong market returns compared to when this tolerance is determined at a time of significant volatility or after significant market falls. 

While many clients’ tolerance of risk will be unaffected by recent market volatility some clients will be reconsidering their appetite for risk in this new light. It may be appropriate, therefore, to reconfirm client risk tolerance (for a few, some, or all clients as appropriate) in light of recent volatility.

Test the sustainability of clients’ retirement income strategies for uncertain markets

Having reconfirmed clients’ risk tolerance it may also be appropriate to re-test, in the current environment, just how sustainable clients’ retirement income strategies just might be.  

With current levels of retirement savings (and this could be more, the same or less than clients’ started retirement with), asset allocation (previous or revised based on risk tolerance), current and projected income drawdowns and a range of future possible market conditions, just how sustainable is a client’s retirement income strategy?  

Has recent volatility impacted clients’ retirement outcomes? Do existing retirement income strategies continue to be appropriate or are revisions required?

Take, for example, Sally and Steve, a 66 year-old couple with $300,000 each in account-based pensions. They have a 50/50 growth/defensive asset allocation projected to return 6.2% p.a. for growth assets and 3.3% p.a. for defensive assets before fees.  They have cash/TDs earning 3.4% p.a. interest and non-financial assets of $20,000. Assuming desired income from all sources (including Age Pension) of $60,000 p.a. and essential income of $41,782 p.a. ($36,582 (max Age Pension at 20 September 2019) + $5,200 p.a.) adjusted for inflation (assumed at 2% p.a.) and modelled using the Challenger Retirement Illustrator (see the Challenger Retirement Illustrator for all assumptions) we project this income requirement can be met out to age 94, when assets are fully depleted and these clients are then dependant on the Age Pension alone for their retirement income. This scenario is modelled in the chart below as the ‘fixed returns’ line of the chart.

Addressing clients volatility_image 1

Source: Challenger Retirement Illustrator (12/03/2020) using Social Security rates and thresholds effective 20 September 2019.  See Challenger Retirement Illustrator for all assumptions.

While a projection of retirement income that lasts to age 94 may provide many or most clients with a significant degree of comfort it is also appropriate at this point to highlight the potential impact of market volatility on retirement outcomes.  

The above chart also shows retirement outcomes where the fixed rates assumed in our initial projection (6.2% p.a. for growth assets and 3.3% p.a. for defensive assets before fees for every year the projection) are replaced with more realistic expected returns (that are higher or lower and, most importantly, change from year to year). These projections are shown as “Stochastic 1” to “Stochastic 4” on the chart.  These alternative models show client retirement assets depleted earlier (in some cases, much earlier) or later than when using the fixed returns assumption.

While may clients would agree that a retirement income strategy that delivers income to age 94 or beyond was ‘sustainable’ many clients would form a different opinion of the same strategy which (as shown above) could fail as early as age 81. The current retirement income strategy for these clients may require review in light of the current environment. 

The Challenger Retirement Illustrator allows a retirement income strategy to be tested against 2,000 possible market scenarios to allow advisers to test the sustainability of a retirement income strategy, or variations of it.

Present alternative retirement income strategies (where appropriate) 

For many clients their existing retirement income strategy will remain appropriate and no further action will be required.  But, for some clients it may be appropriate to consider strategic alternatives in light of a reduced sustainability of the current retirement income strategy based on market conditions and expectations.

One alternative that may be worth modelling for consideration is adjustments to total income drawdowns, either immediately or stepping down later or over time, to reflect a preparedness to prioritise sustaining retirement savings over spending. Reducing drawings from savings, even by a modest amount, can significantly enhance the sustainability of a retirement income strategy.

Clients may also be prepared to see the value of estate benefits reduce from the estimates of their original plan in light of market changes and a desire to maintain retirement spending. These lower projected estate benefits will be reflected in revised modelling.

Recent research2 shows that the majority of clients with a defined benefit income stream or lifetime annuity as their main source of retirement income are unconcerned about outliving their savings. This is probably not a surprising finding - having a source of income that will last for life will be a key factor behind this lack of worry. But, this does present an opportunity – if clients are concerned by current market volatility, a level of guaranteed lifetime income could ease that concern.

A partial allocation of assets from the defensive component of a client’s retirement savings to a lifetime annuity could ensure clients a guaranteed level of income for life, irrespective of how long they live or how investment markets perform. This guaranteed income, complementing income from the Age Pension (if applicable), could help clients meet essential expenses through retirement. The chart below illustrates this application.

Addressing clients volatility_image 2

Importantly, when we model the sustainability of a retirement income strategy we see material improvements in the sustainability of income for many clients where a partial allocation to a lifetime annuity is made.  

If we model the sustainability of retirement income strategies for Sally and Steve (introduced above) using the Challenger Retirement Illustrator, we see a significant increase in the chance of meeting these client’s retirement income requirements.  

Without using a lifetime annuity we estimate that in just 23% of the 2,000 simulations will Sally and Steve meet their desired level of spending (to the point at which there is a 50% chance that one of them is still alive – or age 94 in this case) and in just 28% of scenarios will they meet their essential spending requirements.

However, where me make a modest allocation to a lifetime annuity (in this case 22% of the assets from the account-based pensions to provide a guaranteed lifetime income of $5,623 p.a. - which when combined with the maximum rate of Age Pension will meet Sally and Steve’s essential spending requirements) we see that they can meet desired spending in 39% of the 2,000 modelled scenarios and meet essential spending in 100% of the modelled scenarios.

The combined income stream strategy is illustrated in the chart below.  

Addressing clients volatility_image 3

Source: Challenger Retirement Illustrator (12/03/2020) using Social Security rates and thresholds effective 20 September 2019.  See Challenger Retirement Illustrator for all assumptions.


Implement strategy adjustments (if required), continue monitoring and adjust again (if required)

Reconfirmation of clients’ risk tolerance, testing the sustainability of retirement income strategies and the consideration of alternative retirement income strategies may necessitate a change of retirement income strategy and this, in turn, will require implementation.

It is important to remember that a retirement plan isn’t a static document and should continue to evolve over time, adjusting not only with changes in markets but changes in the lives of clients. With this in mind it might be timely to remind clients of the ongoing benefits your continuing advice provides. This ongoing advice can be an additional element assisting to ease client concern in these uncertain times.

Conclusion

While recent volatility in markets may have been challenging and confronting for many clients, for many advisers this represents an opportunity to add significant value to clients, ensuring their retirement plans remain appropriate in these uncertain times and actively reducing clients’ concern.  

 
[1,2] National Seniors Australia and Challenger, Retirement Income Worry: Who worries and why?, January 2020