The pros and cons of drawdown

According to Jeff Steedman, head of self-invested personal pension and small, self administered scheme business development for Xafinity, the benefits are clear.

Regularity 

Firstly, there is the prospect of the individual being able to dictate the regularity of their income stream from the pension, giving them some element of security in knowing their outgoings will be able to be met.

This also enables clients to carry out tax planning in a more efficient manner, as Rachel Smith, associate consultant for Mattioli Woods, explains.

"Drawdown offers greater opportunities for individuals to manage their own income tax position, not always the case with defined income from an annuity, which allows clients to maximise tax efficiency should they receive income from other sources."

Flexibility

Steven Cameron, pensions director for Aegon, comments: "Since the freedoms became available, more people are preferring the flexibility that a flexi-access drawdown plan offers."

With the opportunity now for people to take their pension as drawdown rather than an annuity, more flexibility has meant fewer people getting locked into abysmal annuity rates over the past three years.

Moreover, the flexibility is not just about choice, but about how people want to take their money, and how regularly. 

Mr Steedman says: "[Drawdown] allows people to have the ability to withdraw funds on an ad-hoc basis, while allowing [the pension] to remain invested throughout the drawdown period."

Control

For Ms Smith, the "main benefit" of drawdown is that "clients can access their savings in a way that meets their needs, whether it's to cover a large, one-off expense, or to maintain their standard of living".

"Drawdown also provides some control over if or when to buy an annuity," Mr Steedman adds. This is an important point, when one considers the low interest rates in the UK.

These are currently trundling along at 0.5 per cent since March 2009 - and this has had a knock-on effect on the gilt rate, meaning a reduction in the income available if people were to purchase an annuity.

Inheritance

Then there is the ability for this to be passed down to a nominated beneficiary on death - and the income from this could be a huge boon to younger people struggling to get onto the housing ladder or to fend for their families.

The pension freedoms brought a boost for those who stand to inherit a defined contribution pension if the deceased was under 75: the inheritor can draw down from that fund without tax.

Mattioli Woods summarises the main points thus: 

• Death of the pension fund member before age 75 allows for the inheriting individual to receive the pension fund as a pension fund in their own name without tax - they may also withdraw the entirety of this inherited fund without income tax, inheritance tax or capital gains taxes in their own name
• On death after age 75, the pension fund is passed to the receiving individual, again tax-free, but if they wish to withdraw it (as an income or a lump sum) they must pay income tax at their marginal rate. 

Fiona Tait, technical director for Intelligent Pensions, comments: "The fact a pension fund still exists, means the client can continue to invest their money for growth if they want to, and they can pass on the value of the fund to their chosen beneficiaries in the event of their death."

But there are also downsides

Several of the issues cited by advisers, providers and clients are around the costs, complexity, investment risk and investment suitability concerns.

Complexity

Complexity and a lack of understanding of how drawdown works is a key concern. This is a point made by Mr Cameron, who states: "Comparing the offerings of different providers is more complex for flexi-access drawdown.

"Unlike annuities, it is not about comparing a rate, as there are many different features to take into account. As everyone will have different needs and preferences, it is not straightforward to choose. 

"Aegon continues to recommend that individuals seek the support of a professional adviser."

In 2016, Aegon published an eight-point plan to help people pick a flexible drawdown product. This can be seen in the info box below. 

Volatility and withdrawal risk

There are two potential problems when it comes to risk: a significant and prolonged market drop during decumulation, and the potential for an individual to pull too much income from the fund in the early years, leaving the pot to run dry in later life.

Both are risks that will affect the longevity of the individual's money.

Ian McGowan, head of fund proposition for Scottish Widows, comments: "Investment markets can be volatile and a significant loss early in drawdown can have a much bigger impact on a client’s ability to sustain their income than losses later in retirement."

"The fact the fund is still invested means it's still exposed to market risks and could fall in value or fail to sustain income levels when returns are negative," says Fiona Tait, technical director for Intelligent Pensions.

She says this is particularly important for clients withdrawing income, as "investment losses may have to be immediately realised before the market recovers."

This highlights the importance of taking advice from a qualified adviser around income levels and their ongoing suitability. Rachel Smith

Evidently, people do not want to get into retirement and suffer a huge investment loss akin to the 2008 financial crisis, just when they have stopped accumulating into a pension, as well as ceased to work and gain an income through their employment.

However, simply avoiding markets because of volatility is not likely to be an appropriate or reasonable option for those remaining invested in a drawdown product.

For this reason, Mr McGowan suggests: "Rather than take a reactionary approach to changing market events once the client is in decumulation, it’s actually better to be pro-active and plan how much volatility and investment risk a client is prepared to tolerate."

In a 2017 study from the University of York, the authors suggested the optimal amount that could be drawn down was 4 per cent.

This, they said, would be useful to a pensioner in terms of income provision as well as a sustainable rate of withdrawal on a fund without subjecting the fund to the possibility of sequencing risk - that is, the risk of losing too much, too soon, and not being able to recoup the performance.

The 36-page study, called Decumulation, Sequencing Risk and the Safe Withdrawal Rate: Why the 4 per cent Withdrawal Rule leaves Money on the Table, built upon earlier studies which aimed to work out the perfect withdrawal rate (PWR). 

Take out too little and you might not be able to meet basic living expenses: take too much out and you could significantly, irreparably, damage the pension pot's ability to continue to support you through the rest of your life.

Ms Smith says: "This highlights the importance of taking advice from a qualified adviser around income levels and their ongoing suitability, not only to ensure these risks can be mitigated but also to keep the investment and drawdown strategy under review."

Management 

For Mr Steedman, one of the biggest drawbacks is the fact drawdown requires "careful management and support" to deal with all the above issues, as well as the "liquidity, underlying investment management monitoring and tax planning".

He says for all of this, one should seek ongoing support from a "good financial adviser" - but all of this management carries a cost. 

Education should go some way to helping people be better managers of their money both in accumulation and decumulation. 

Claire Felgate, head of DC investments for BlackRock, states: "We believe it is important to continue to educate people that planning for the long term, and investing for retirement, is crucial."

This is as important to those starting out on their savings journey as well as for those entering into their pensionhood.

simoney.kyriakou@ft.com