The issue of safe withdrawal rates, sometimes called sustainable income rates, has come increasingly into the spotlight for advisers serving baby boomers approaching or in-retirement, following the rapid decline of annuity purchasing since the then chancellor George Osborne went public on Pension Freedoms in April 2014.
The FCA’s recent Bulletin (Issue 12) published in March shows that more than twice as many pots have entered into income drawdown policies rather than annuities over the last two years. A total of 345,265 pots have been used to buy income drawdown policies while 152,843 moved into annuities. Scarily, 620,150 pots were cashed out completely since October 2015.
The growing army of ‘drawdowners’ must be wary of potential traps, including ‘pound-cost ravaging’. This triple whammy happens when markets fall steeply. Retirees then suffer falling capital value of the fund, further depletion due to the income they are taking by selling assets at rock-bottom prices, and a drop in future income as dividends follow asset values downwards.
This poses a problem every time markets take a tumble but is especially dangerous near the start of retirement because investors can rack up big losses and never make them up again if they are not careful.
One recent lurid headline suggested that as a result of this triple whammy some drawdown-based incomes could be cut in half in short order.
So, what tools and techniques are now available to help the majority that are either cashing out in full or purchasing an income drawdown policy in retirement? There is already lots of guidance available in this area. You can read about safe drawdown levels sitting at somewhere between 2 per cent and 5.8 per cent of total value of assets held in the policy.
Some prefer to peg the drawdown level at close to average annuity rates which currently sit around 4.8 per cent. But surely it depends hugely on the performance of the assets the policy is investing in, the size of the overall fund at the start of drawdown, the position on the economic cycle and much else besides?
There are well-trodden strategies for preserving drawdown funds during market downturns by building up three to five years’ worth of cash reserves which can be used for drawdown payments so you are not selling assets into falling markets, thereby crystallising losses in bad times like the recent Great Recession. But holding five years of cash, maybe 20 per cent of the portfolio, at today’s nugatory interest rates feels like standing in the rain waiting for a delayed bus.
- People using drawdown must beware of traps, such as 'pound-cost ravaging'
- Tools exist to help people calculate withdrawal rates
- Advisers are well placed to help clients write down their at-retirement objectives
Others prefer to choose emerging hybrid products which offer to lock in part of your retirement funds to secure a guaranteed income. Such lock-ins can be judiciously upped over time, perhaps by taking profits from the drawdown portfolio in good times. There is a win-win element to this strategy. Having a bedrock of secure income enables the adviser to increase the equity proportion of the remaining drawdown portfolio, so it is quite likely there will be periods of future gains to harvest.