The risks that come with income drawdown

A large, currently captive sum of money is expected to be moved out of pension funds immediately following the new rules’ introduction. Hargreaves Lansdown’s head of pensions research, Tom McPhail suggests around £5bn, involving up to 400,000 transactions, will flow out of pre-retirement funds into annuities, drawdown and ad-hoc cash withdrawals in the first weeks and months after 6 April.”

Beyond the sheer volume of transactions, a shift in where that money goes is anticipated. In the past the overwhelming majority would have been used to buy an annuity, often as a default. While innovative products are expected to come in to exploit the freedoms, the other existing established solution – income drawdown is also anticipating an increase in take-up.

Drawdown became more accessible immediately following the 2014 Budget. The amount that could be drawn rose from 120 to 150 per cent of Gad rates. Previously pensioners had to demonstrate secured income of £20,000 pa before entering drawdown, that figure reduced to £12,000. These changes made drawdown more accessible, but the implementation of wider freedoms will effectively democratise the product further, enabling flexi-access drawdown’, which will allow almost anyone to use drawdown.

Occupational defined benefit schemes and closed-book life insurance companies may not offer drawdown. According to Mr McPhail, “These companies are contemplating the possibility of clients simply walking out of the door. We may therefore see them turning to third-party providers.”

Billy Burrows, associate director at Key Retirement Solutions, also expects new companies to try to encroach on the market. He identifies a current trend in the development of choices that some investment houses are offering,

“UBS is looking at providing drawdowns which not only pay an income but are also less volatile,” he says.

This shift is important to IFAs. However, more pertinent to the advice profession is that “some insurance companies are now offering non-advised drawdown products because they can sell more of them”.

At the core of the IFA’s role is the issue of sequence of return. He adds: “there is a distinction between investing in retirement and investing for retirement.”

The Graph shows the impact of commencing drawdown in different markets. It is based on the performance of the FTSE 100 and shows the impact of drawing £12,000 pa from a £100,000 pot invested entirely in the FTSE 100. The graph does not account for charges and is purely illustrative, showing how identical drawdown policies could diverge based purely on when they were started.

A drawdown that commenced on 1 January 2007 would have dropped to £42,117 after five years, and 16,949 by the start of 2015. But an identical scheme started just two years later would have seen its value rise by 8.6 per cent after five years and still hold almost all its initial value.

Concerns around individuals using their new freedoms to cash in their savings for a speedy convertible may have been exaggerated, but there are still risks that those who pursue an approved course such as drawdown may end up outliving their pot.