Most pre-retirement conversations about risk start with the wrong question. “How much risk can you take?” invites a single answer, and in a rising market that answer tends to be generous. The regulatory framing is more useful: the FCA’s suitability rules ask firms to establish the risk a customer is willing and able to take. That phrase splits the question in two, and the two halves can give very different answers.
Willing is attitude. Able is capacity for loss. A portfolio can be perfectly matched to your attitude and still be wrong for your circumstances. Before you move from accumulation to drawdown, you need both answers separately, in writing, with numbers attached.
Two questions, not one
The suitability rules in COBS 9.2.2R require firms to take account of a customer’s preferences regarding risk taking, their risk profile, and to ensure they are able financially to bear any related investment risks consistent with their investment objectives. The FSA’s 2011 guidance consultation on assessing suitability put it plainly: capacity for loss is the customer’s ability to absorb falls in the value of their investment, and if any loss of capital would have a materially detrimental effect on their standard of living, that should be taken into account in assessing the risk they are able to take.
That definition is worth reading twice. It is not about how you feel. It is about what a fall would do to your life.
So the audit has two parts:
- Attitude to risk. If your portfolio fell 25% over eighteen months, what would you actually do? Not what you hope you would do. What you did in the last fall you lived through, and what you would do if the fall arrived two years into drawdown with no salary to top the pot back up.
- Capacity for loss. If the portfolio fell 25% at the point you start drawing an income, what happens to the money you need for the bridge to State Pension age? Which spending is fixed, which is discretionary, and how many years of the fixed spending can be met from sources that are not exposed to the fall?
These are different questions with different evidence. A questionnaire score answers the first, badly. Only your cash flow answers the second.
The label on the report is not the process
Suitability reports usually carry a risk category: cautious, balanced, adventurous, or a number on a scale. The label is the output. The question worth asking is what produced it.
The FSA’s review found that although most advisers and investment managers considered a customer’s attitude to risk, many failed to take appropriate account of their capacity for loss. It also found that some firms unduly focused on the risk a customer is willing to take and failed to take sufficient account of the customer’s other needs, objectives and circumstances. And it was explicit that firms remain responsible for assessing suitability, including the risk a customer is willing and able to take, even when using tools.
That last point matters for your audit. If your risk category came out of a profiling tool, the tool did not make the judgement. Your adviser did, using the tool. The tool’s limitations are your adviser’s problem to manage, and a reasonable question to ask about.
One caution on the source: the FSA review examined files from 2008 to 2010 and was published in 2011. It is evidence of the failure modes the regulator identified, not a current assessment of any firm or tool. Use it to know what to ask, not to assume what your adviser has done.
A paper rehearsal you can run yourself
The most useful test before drawdown is not a score. It is a rehearsal. Run the first five years of drawdown on paper, then stress it.
Step one: write down the income you need from the portfolio. Not the income you would like. The amount that must come from invested assets in years one to five of drawdown, after State Pension, any defined benefit income, rental income and cash reserves. Date-stamp the figures to the tax year you are using.
Step two: split it. Fixed spending is the part that does not flex: housing costs, utilities, insurance, essential transport, care commitments. Discretionary spending is the part that can wait a year or two: travel, gifts, home improvements, the second car.
Step three: apply a hypothetical fall. Take the portfolio value at the point you plan to start drawing, reduce it by 25%, and ask a simple question: can the fixed spending still be met for five years without selling assets at the bottom? If the answer depends on the discretionary spending being cut immediately, say so now, while it is a decision rather than a reaction.
Step four: identify the bridge. The years between your stop-work date and State Pension age are the years with the least flexibility and the most sequence risk. Check the date against your own scheme rules and your own birth year rather than relying on a rule of thumb.
This is not a forecast. It is a rehearsal. The point is to discover, on paper, which parts of your plan depend on the market being kind in the first few years.
What to ask your adviser
These questions are not adversarial. They are the conversation the Consumer Duty expects firms to be able to have. The Duty requires firms to act to deliver good outcomes for retail customers, and its cross-cutting rules include avoiding causing foreseeable harm. A drawdown plan that only works if the first years are benign is a foreseeable harm worth discussing before it happens.
Ask:
- How did you assess my capacity for loss separately from my attitude to risk? What evidence did you use?
- Which risk-profiling tool did you use, and what are its limitations in my case?
- How would the recommendation change if the portfolio fell 25% in year one of drawdown?
- What income is this plan designed to deliver in the first five years, and which spending does it assume I can cut?
- How does the plan change if my stop-work date moves, or if the bridge to State Pension age is longer than we assumed?
If the answers are vague, that is information. A suitability report that cannot explain its own process is a report you should not rely on at the point of drawdown.
Why a bull market makes this harder
There is a reasonable suspicion, though not a proven finding in the sources here, that rising markets make risk questionnaires easier to answer generously. A portfolio that has gone up feels safer than one that has gone down, even when the underlying assets are identical. That is a prompt to test the process, not a statistic to quote.
The practical response is the same either way. Do not rely on how you feel about risk in a good year. Test what your plan requires in a bad one. The two-question audit, the paper rehearsal and the adviser questions above are designed to be run now, while the market is still friendly and the decisions are still reversible.
The uncomfortable truth
Most people approaching drawdown have a clearer picture of their attitude to risk than their capacity for loss. Attitude is a feeling, and feelings are easy to report. Capacity is a calculation, and calculations require you to look at the spending you would have to cut and the years you would have to fund without selling into a fall.
The gap between the two is where plans fail. Not because the market fell, but because the plan was never tested against a fall before it happened.
Run the rehearsal. Ask the questions. Put the answers in writing, dated to the tax year. Then decide whether the plan you have is the plan you can live with when the first five years of drawdown are not kind.
For a related question on what to clarify with an adviser years before retirement, see The Question You Should Be Asking Years Before You Retire.
FAQ
Is attitude to risk the same as risk tolerance?
In regulatory language, attitude to risk is the customer’s preference about risk taking. Capacity for loss is the financial ability to absorb falls. The suitability rules require firms to consider both, and the FSA found that capacity for loss was often the weaker part of the assessment.
Does a risk-profiling tool decide my risk category?
No. The firm remains responsible for assessing suitability, including the risk you are willing and able to take, even when using tools. The tool supports the adviser’s judgement; it does not replace it.
What does the Consumer Duty add to this?
The Duty requires firms to act to deliver good outcomes for retail customers and includes a cross-cutting rule to avoid causing foreseeable harm. It came into force on 31 July 2023 for new and existing products and services, and on 31 July 2024 for closed products and services. It does not guarantee any particular outcome, but it does give you a legitimate basis for asking how a drawdown plan would behave in a fall.
Should I test my plan against a 25% fall?
That is a hypothetical used here to make the rehearsal concrete, not a forecast or a regulatory threshold. The useful number is the one that would materially affect your fixed spending in the first five years of drawdown. Choose a fall large enough to be uncomfortable and small enough to be plausible, and write down what you would do.