More and more people are now relying on defined contribution pensions to provide their income in retirement. According to the FCA retirement income survey in 2018/19, almost three times as many people choose to draw their income from their pension pot than buy an annuity. This decision then leaves them with the difficult task of managing their pot over the rest of their lifetime.
The same survey also found that 48% of people did so without taking any regulated advice or guidance. This finding may be because people are put off from taking advice by the cost, but it may also be that many people are not entirely comfortable with financial matters and figures in particular.
A recent report by PensionBee entitled “Drawdown Doldrums” (2020) also emphasised the need for simple investment and communication pathways to help savers manage this process.
It is therefore clear that there is a real need for tools that people can use themselves to help them successfully manage their retirement income. This article looks at one possible approach using the ‘risk bowtie’ framework which provides a logical and visual tool to help them do this.
For the purposes of this article, I have assumed that the pensions pot is the main source of income in retirement and that a decision to purchase an annuity has already been excluded. In practice, people may have other savings or income which means that they can take more risk with their pot than they would do otherwise, in the knowledge that they can rely on this other money if needed.
Alternatively, they may be in receipt of state benefits and their entitlement, often means-tested can be adversely affected by decisions made at retirement. It is essential that these wider considerations are taken into account but for the purpose of this article, I have assumed that there is no entitlement to state benefits.
Using a Risk Bowtie to Help Manage Your Income
When a person first retires, they need to make decisions about the level of risk they are willing to take in the management of their pension pot in order to provide a durable level of income. In this context, ‘risk’ is the chance of not having enough money to provide an income for life. Over time, unexpected events will inevitably occur (such as changes in investment markets or changes in personal circumstances) and so people need a way of revisiting the level of risk that was initially accepted to adjust it accordingly.
The risk bowtie is a risk management tool that brings together the various actions that can be used to manage this risk in a logical and visual manner. In the risk bowtie framework, there are two steps:
- The first step involves deciding on the actions that need to be taken in order to set the level of risk that a person can accommodate (preventative actions).
- The second step involves revising these actions, as events unfold, to adjust the level of risk being taken (corrective actions).
Diagrammatically this might be summarised as;
Events → Preventative actions → Fund → Corrective actions → Income durability
What Does This Mean for Pensions?
With more and more people having to rely on defined contribution pensions in their retirement, there is an increasing need for new ways to help them make sensible choices about managing their retirement income.
It is important for people to visualise the risks associated with income drawdown, and so help them to successfully manage their future income.
For more information please download and read our in-depth article that includes examples of the principles discussed here. You can also keep up to date with the latest news from Pi as well as the latest industry insights and trends. Alternatively, please feel free to contact us today.