“And above this, again, is the top tier, [the] 'nice to have'. Income which can be used for things like leaving a legacy or a special holiday.”
Mr Simmons continues: “To establish a sustainable level of income, cash flow modelling can be used to paint a picture to clients of the potential outcomes, and stress testing is an excellent way of helping clients to understand their capacity for loss.
“Importantly, it also helps advisers document the client’s understanding as part of an evidence-based income strategy.”
But he warns any assumptions used in the cash flow modelling process need to be both reasoned and reasonable, with the underlying process itself stress tested.
He adds: “Simple methods of stress testing include assuming negative returns losses at different stages throughout retirement, and looking at the impact of a lower long-term growth assumption.
“Advisers need to consider the expected returns from the assets they are investing for their clients, perhaps by using stochastic models or anticipated growth rates provided by the investment manager.”
If they are in good health, then a client's drawdown pension could remain invested for two or three decades, or even more, notes Patrick Connolly, chartered financial planner at Chase De Vere.
He says: "To achieve real returns over this timeframe they need to hold at least some of their money in equities.
"However, as they are likely to be relying on their pension money to provide an income for the rest of their life, they should also hold safer assets, such as fixed interest, to provide diversification and also some protection if stock markets perform badly."
What is the sequence of returns risk?
Most investors accept some short-term volatility as the price worth paying for the opportunity to realise gains over the long-term.
However, in decumulation, volatility losses can be compounded when assets are sold during a downturn.
This is known as the ‘sequence of return risk’, or ‘pound cost ravaging’ and it is the risk of an investment experiencing volatility when in drawdown.
“When in accumulation, investors have the capacity to absorb volatility to varying degrees, depending on their circumstances,” explains Ms Owen.
“However, when withdrawing monies from a pot, volatility becomes a much greater concern because of the impact this has on fund value.”
But this risk can be managed in several ways.
Most advisers will use a combination of strategies, suggests Mr Simmons.
He explains: “These include using smoothed funds that help reduce volatility, taking withdrawals out of ‘natural income’, regularly monitoring different ‘pots’ and withdrawing from those that have performed best, and calculating and regularly reviewing a sustainable withdrawal rate.
