Income drawdown has become a highly complex area of advice and there are lots of things to consider when choosing how best to manage the available options.
With annuity rates still close to a record low and the flexibility of pension freedoms uppermost in people’s minds, drawdown has become the default for most people with above-average sized pension pots. While almost everybody understands what drawdown is, and advisers are more than confident in explaining the advantages and disadvantages, not all advisers and certainly not many non-advised customers understand what is actually happening under the bonnet.
When advising on annuities, advisers know what success looks like because it is about selecting the right options and getting the highest possible annuity income. But when it comes to advising on drawdown, this is much harder because there are so many moving and interconnected parts that identifying the success factors at the outset is difficult.
This begs the question of what it takes to run a successful drawdown plan. This might seem a simple question, but it is now one of the most important questions in retirement planning and one to which there are no clear-cut answers.
I have identified six separate, but interrelated, factors advisers need to take into account when considering how to arrange a suitable drawdown plan. These include:
- Income strategies
- Sustainable income
- Investment strategy
- Managing sequence of returns risks
- The effect of charges
It is always helpful to remind ourselves and our clients that the basis for a good drawdown solution is to have a plan. This does not have to be complicated, but without a plan drawdown can easily end up losing money.
Taking the tax-free cash without taking income might seem like a plan, but unless some thought is given to how income is taken in the future, it is just a holding exercise. More and more people are taking tax-free cash and leaving the balance of the pension pot to grow. While this is perfectly understandable and probably suitable, it is still important to plan for the future to ensure the investment strategy is appropriate and give some thought to future income needs. After all, taking the tax-free cash might mark the point when retirement planning changes from accumulation to decumulation.
A useful strategy often used is ‘phased retirement’. There are lots of different permutations, but an essential ingredient is taking tax-free cash in stages and using it to pay income, thereby reducing the tax bill. Some of my best advice has included elements of phased retirement.
- Drawdown has become the default for most people with above-average sized pension pots.
- More and more people are taking tax-free cash and leaving the balance of the pension pot to grow.
- 3 per cent is too low a sustainable income for many people because they need a higher level of income.
It is worth mentioning that one of the biggest barriers to phased retirement, and the reason many people take cash at the earliest opportunity, is fear the government will take it away. I have heard this threat for more than 25 years. Equitable Life was telling clients this in the 1990s. Although I think tax-free cash is here to stay, it is an understandable that governments are not trusted.