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How to evidence suitable drawdown advice

The FCA is focused on the topic of retirement income advice

How to evidence suitable drawdown advice

18 May 2020

Carmen Bews

In particular, the regulator wants to make sure that any drawdown advice is in the client’s best interests, given the increased risks involved. 

It's important that drawdown advice is well documented, and that the advice given is reviewed regularly.

As such, it can be a challenge to make sure a drawdown file fully demonstrates suitability to achieve the client's overall objectives, as well as striking the right balance between growth, income and estate planning.

We recommend including the following information on a drawdown file in order to evidence suitability:

The client's overall financial position

 

The file should record all aspects of the client’s current financial position, including savings, investments, all pensions and current income and spending needs. 

If the client has a spouse or partner, their income in retirement should also be included.

A state pension forecast should be on file to evidence the amount the client will receive and when, and if this is fully funded. 

The file should make a note of whether the client has any financial dependants and the impact of the advice on them.

Details of the client’s emergency fund should also be taken into account, with enough cash in place to cover the client’s short-term spending needs.

If a client could be classed as vulnerable, then the file should demonstrate if this has been considered. 

The client's retirement objectives

It's worth recording the client's retirement objectives on the fact-find and in the suitability report to establish:

  • when the client wishes to retire, and importantly, whether they plan to continue working while receiving pension income
  • the client’s income needs
  • any planned spending such as home improvements or holidays
  • their essential and discretionary spending, and any expected changes to this in retirement
  • any specific requirements such as fund choices

Key things to consider before taking pension income

 

The file should provide evidence that the following points have been taken into account and addressed as part of the suitability report:

  • The client’s state pension entitlement
  • Any state benefits the client is receiving that may be affected
  • The money purchase annual allowance and whether this reduced limit will affect the client
  • The client’s lifetime allowance and whether this is likely to be exceeded
  • Death benefits and taxation on death
  • How to take benefits in a tax-efficient way

Evidence all options have been discussed

 

All other options of funding the client’s retirement income need to be talked through, with the conversations documented on file and in the suitability report. 

We recommend these include conversations in relation to flexi-access drawdown, uncrystallised funds pension lump sums, annuities or enhanced annuities, scheme benefits and the small pots allowance where appropriate.

Making sure the client’s essential spending is covered by guaranteed or secure income is best practice.

It may be that the client is looking to access their lump sum only.

In this case we recommend that the amount they need and why is recorded in the fact-find and suitability report, as well as the other options considered.

For example, if a client requires £20,000 to fund their child's wedding and has other investments or savings, it's worth documenting why these haven't been used.

You'll also need to consider any potential inheritance tax liability. 

Where a flexible income is being recommended, the suitability report should advise the client on the annuity that could be purchased with the fund and should confirm that the client can move into an annuity at any time.

Attitude to risk

 

It's important to capture the conversations you have with clients around attitude to risk, capacity for loss and expanding on the answers given in the risk profile questionnaire. 

These conversations should reflect the additional risk of drawdown such as inflation risk, longevity risk/mortality drag, volatility risk and sequence of return risk.

The suitability report should then take into account the personalised conversations you had covering these areas.

The report should also note the disadvantages of the drawdown recommendation, as well as all the relevant risk warnings in the main body of the report.

Tax implications

 

The file needs to demonstrate that you and the client have considered the way pension benefits are taken to mitigate tax, including increasing a potential inheritance tax liability.

It's expected that the suitability report will document how the client is being recommended to take an income and how this impacts income tax and their lifetime allowance.

Where relevant, the client should be made aware of any reduction in their annual allowance as a result.
 
We recommend the suitability report also explains the death benefits offered under drawdown and the tax treatment.

Investment strategy

 

Does the fact-find note conversations around the client's investment preferences?

For example, it's worth including whether they have a preference for ethical or socially responsible investments, and active or passive investments.

The investment strategy should be personalised to the client - this should be evidenced in both the fact-find and the suitability report.

Charges

 

The suitability report should be transparent when it comes to charges.

We recommend all charges including product, investment and adviser charges are disclosed in the suitability report in both percentage and cash terms so the client is fully aware of the costs involved.
 
The suitability report should consider whether the drawdown recommendation and the investment strategy are suitable, and are able to achieve and sustain the client’s objectives taking into account the costs.
 
It should also include the critical yield figures contained in the drawdown illustration, with commentary on whether these appear achievable.

A sustainable drawdown strategy

 

We recommend the file and the suitability report should demonstrate the drawdown strategy being recommended is sustainable.

The recommendation may be to take a lump sum with no immediate need for income.

Even in this case,  the suitability report should demonstrate the drawdown strategy is sustainable, taking into account the client’s future lump sum and income needs.

Use the report to show the client can afford to take the lump sum now, and highlight how this may affect their future income.

After capturing all the relevant client information, it's worth sense checking your recommendation. 

While the client may want their full tax-free cash now, maybe for a holiday or new car, it's important to consider whether this may be in the best interests. 

Ultimately, the file needs to demonstrate this is the case.