PensionsMar 16 2015

Who should go into drawdown - and who should not?

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Most over-55s are likely to be in bed or getting rained on with their grandchildren on a beach somewhere when the pension freedoms come into effect on Easter Monday , if they heed the advice of pensions minister Steve Webb.

He makes a fair point: there is no deadline, expiry date or obligation to withdraw from pension pots when the clock strikes midnight on that spring morning.

“People should take their time, seek advice and make informed decisions,” he says. The mantra is that we are living longer and much forethought must go into retirement planning to ensure a sustainable income source throughout.

Considering the likely shift of default option from annuity to unfettered drawdown, the risks of that planning not working out and the pot running dry (or at least such that whatever the objectives they may not be met) will shift to individuals and their advisers.

Who will go for drawdown?

Flexible access drawdown, the new basic income option that replaces flexible drawdown and removes its minimum income threshold, allows you to take as much income from your plan as you like and to vary it as you see fit.

The afforded flexibility, continuing low interest rates and lack of confidence in traditional income sources means it will be the popular choice. So how will it pan out post-April 6: who is FAD suitable for, at what income level, and who not?

Since the pension changes, a number of firms have lowered their minimum pot size to £30,000 - picking up where the trivial commutation limit leaves off.

The Association of British Insurers recently revealed that in Q4 2014, the number of drawdown contracts sold by its members more than doubled compared to the same period in the previous year to 11,454, while average pot size fell more than 30 per cent from £83,400 to £57,600.

Adrian Boulding, Legal & General’s outgoing pension strategy director, says FAD will be very popular. “It will appeal to anyone not yet ready to say their needs are now fixed for the rest of their life. That’s probably most at the point of retirement nowadays, so perhaps up to 400,000 people a year retiring off DC pension plans.”

Rod McKie, retirement propositions head at Zurich Life, says their research suggests that nearly one in three are intending to drawdown after 6 April. He believes with the small pot limit at £30,000, most at and below this will likely be taken as cash, making an effective FAD minimum of “around £50,000.”

Balancing act

Those who go into drawdown must be comfortable remaining invested and have the requisite tolerance for risk. Advice is strongly recommended by most - though there are more non-advised options coming to market - as is monitoring fund performance.

Mr Boulding says the danger is some may draw-down too quickly and run out of money. “My advice to people choosing this route is to use common sense and remember you can only spend your pension pot once.”

Claire Trott, head of technical support at Talbot and Muir, said people need to be willing to be involved in the process, FAD is not suitable for those who want to arrange their income ahead and not have to think about it going forward.

“Decisions will need to be made, sometimes unpleasant ones, if the investment performance is low or income taken too high. They have to be willing to take the risk with future income because there are no guarantees with FAD that it will outlast them.”

Garry Latimer, innovation architect at Aegon, emphasises that the flexibilities inherent in the new income drawdown mean it could be a sensible choice for many. While funds are at the mercy of the markets, they at least stay invested and benefit as markets grow.

“Flexi-access with guarantees provides a balance between security of income, potential to grow, flexibility and access if needed and to respond to change,” he says.

“It won’t be right for everyone, but with the right investment choice and responsible use it’s no worse than taking and spending the whole pot or putting it in a vehicle that makes it easy to spend and with growth that may not keep pace with inflation.”

David Trenner, technical director of Intelligent Pensions, said FAD should only be used to provide sustainable income, although could be useful if a lump sum is needed if getting a loan at reasonable rates is difficult. The tax-free option should only be used to clear borrowings, he added.

“For people who rely heavily on their pension funds to supplement their state pension and provide the basic necessities, FAD is not suitable. These people may believe annuities are not for them, not least because they underestimate their life expectancy,” he says.

Not black and white

A third way is becoming increasingly apparent for those in Mr Trenner’s conundrum. Not ‘either, or’, but ‘and’: the age of the blended solution may be coming.

Fiona Tait, business development manager at Royal London, agrees with those who predict an increase in the use of drawdown plans

“I don’t believe however that this means people will never use annuities,” she says. “I’m sure some will use a combination, either in tandem or one after the other, to meet their ongoing needs throughout retirement.”

Mr Boulding elaborates that he expects the way most will run it by determining the regular monthly amount they want depositing in their bank account that will cover regular outgoings.

“On top of that, they may ask for additional amounts from time to time, a lower amount or to miss a month’s payment if they have unused funds building up in their bank account.” Later in life, they may still buy an annuity, perhaps aged 75 when settling down into a routine pattern of retirement.

Rob Yuille, ABI’s retirement policy manager, says figures for drawdown sales reflect the diverse needs and preferences of the population and “is a reminder that savers should not be pigeon-holed or told their choices are wrong, but need advice or guidance to help them find the right solution”.

jonny.paul@ft.com