"The adviser needs to ensure that he or she is keeping abreast of a wide range of developments to ensure their recommendations are the best solution for the customer"
The pace of change in the later life market is accelerating all the time. If you’re an adviser active within it, or even if you’re not, do you feel you’re keeping up to date?
The Pension Freedom changes in 2015 undoubtedly introduced some seismic changes in the options available to consumers. The aftershocks and the regulators’ reactions to them continue to be felt.
The later life borrowing market also continues to evolve; in March of this year the FCA changed its rules an advising on retirement interest-only mortgages. There has been a great deal of market chatter around RIO products, who might be next to market and what it will mean for the sector. It is still relatively early days in this space, and should not perhaps be viewed in terms of a carnival for advisers just yet. What we can say is that new products and solutions are being introduced to the market all the time – you might not be aware that lifetime mortgages are now available on buy-to-let properties and second homes.
In all of this market change, I like to look at it from the consumer solution point of view.
The difference between a product provider and an adviser is that the product provider is seeking to identify customers that could use their product. An adviser is seeking the best solution for their customer and how the products available can deliver that solution. That is the difference the customer pays for.
The rapidly-changing later life market means that product providers have to assess the relevance of their products and how they need to adapt to compete in the evolving market. The adviser needs to ensure that he or she is keeping abreast of a wide range of developments to ensure their recommendations are the best solution for the customer in front of them.
An increasing problem the later life adviser faces is the ability to be able to look across the many different aspects of the later life advice market. Consider this hypothetical case:
A couple are approaching retirement with £70k outstanding on an interest-only mortgage. One of them has been working in an industry where defined benefit pension provision is common. The other has no private pension provision.
A simple approach would be to put the defined benefit pension into place and use that as evidence of income to roll over into a RIO mortgage; job done. Or is it? How would the mortgage be paid after death? One State pension will cease, and the spouse’s pension could be less than the usual formula. For example, it may only relate to part of the pensionable service or may be a contracted out minimum benefit.
Also, what impact would the interest payments have on the couple’s desired retirement spending? Affordability does not necessarily mean it fits in with the household budget.
A lifetime mortgage solution will mean that the couple will have higher spending power but comes at the cost of the reduced equity in the home for their beneficiaries on death. But as they are approaching retirement, the tax-free lump sum is available from the pension. A pension of £14k a year may reduce to £9k a year after taking a tax-free lump sum of £60k.
At this point, the outstanding amount on the mortgage is only £10k, assuming no other debts have to be paid off. How is that outstanding amount going to be repaid? What are the impacts of the reduction of £5k a year on the household budget?
But before we go too far down this route, is the £60k good value? The scheme may offer a transfer value of £322k. If transferred to a defined contribution pension that could result in a tax-free cash sum of £80.5k. That would leave the couple mortgage free with some cash left over.
In these calculations I have used a commutation factor of 12 to one for the tax-free cash and 24 to one for the transfer. As both are extinguishing the schemes’ liabilities for a guaranteed pension, can the former be described as being fair value if the second is also on offer?
But now we are exchanging guaranteed income for life with a spouse’s pension and future payment increases, for the risks of using investments to provide an income. Unless the clients were in poor health it is unlikely that a similar annuity would provide more income.
But this brings us full circle - the interest on an interest-only mortgage would no longer be payable out of taxed income. This would help the household budget.
The ripples from pension freedoms continue to spread out across the retirement pond. If you are going to come up with the best solution for your client and deliver real valuable advice, it is important you know your customer and are aware how other financial products could contribute to finding the solution that is best for them.