PensionsFeb 18 2021

Drawdown is not the panacea

Supported by
Scottish Widows
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Supported by
Scottish Widows
Drawdown is not the panacea
Pexels/Karolina Grabowska

Drawdown has proved popular following the introduction of pensions freedoms in 2015, allowing people to keep their pension savings invested, and take a flexible income to suit their needs.

In its January 2021 official statistics update, HMRC reported that the total value of flexible withdrawals from pensions since pension freedoms has exceeded £42bn.

But drawdown also has potential drawbacks. Justin Corliss, senior intermediary development and technical manager at Royal London says: “Pension freedoms gave consumers greater choice over how they use their defined contribution pension benefits, but with choice comes risk.

“Prior to pension freedoms, people still had the option of income drawdown, but they had limits on how much could be withdrawn per annum, and at age 75 they had to buy an annuity.

"This is no longer the case. So, there is a risk that people may run out of money during their retirement. There is also the danger that consumers fear this and as a result are too cautious with their retirement income pot.” 

Prior to pension freedoms, people still had the option of income drawdown, but they had limits on how much could be withdrawn per annum Justin Corliss, Royal London

Drawdown has other potential disadvantage, including exposure to market fluctuations, as Fiona Tait, technical director at Intelligent Pensions points out: “One of the advantages of income drawdown over an annuity is that it is still invested, and the fund will hopefully grow in value. It is also one of the key risks, given that money that is invested in the stock market can go down in value as well as up, and this is certain to happen at some point in the investment cycle.

“Thanks to coronavirus we saw one of the most dramatic examples of this in 2020, and although fortunately markets recovered soon after, most of the investment houses are currently predicting lower returns in 2021”.

Potential solutions

These market fluctuations can be of particular concern to some clients during volatile times – such as living through a pandemic. As Jessica List, pension technical manager at Curtis Banks observes: “While some market fluctuations are expected, drops like last year’s can still be alarming for people.”

So, how should advisers adjust their clients’ pension income, to address this risk?

Firstly, good, clear communication is key, to ensure clients fully understand what to expect, as Keith Churchouse, chartered financial planner and director at Chapters Financial says: “Managing expectations of drawdown plans and how the value of such arrangements may fall and rise has been paramount over the years. It is certainly vital at the outset of the advice and implementation process.

“We have seen market falls, and in part recovery over the last year. However, this experience is nothing new and clients should anticipate this as part of the investment process.”

Advisers can apply their expertise in a number of ways, as Catriona McCarron, wealth manager at Ascot Wealth management explains: “Last year highlighted the reality of sequencing risk – drawing income from your pension via drawdown in a market dip.

“Advisers should prepare their clients for sequencing risk by stress testing their retirement plans with cash-flow modelling. With careful financial planning, we show our clients how much of a loss their portfolio could weather in the year of review before it would impact on the longevity of their pension”.

McCarron adds: “Advisers can also use diversification of their portfolios to address the risk of drawdown. For example, in a ‘normal’ market with limited volatility, advisers may sell proportionately across a client’s funds to facilitate a drawdown; however, during 2020 we’ve held back between 2 per cent and 4 per cent, in each client’s portfolio to reduce sequencing risk and give some flexibility for ad hoc access without selling funds at a depressed unit price. A similar strategy can be achieved by having a lower-risk section of the portfolio.”

Clients might also consider reducing the income they take from drawdown, as McCarron observes: “Advisers should be having really honest, ongoing conversations with their clients on spending and income affordability as part of periodic suitability assessments and ad hoc conversations throughout the year.”

Churchouse agrees that reducing income can be a helpful strategy: “In some circumstances, we have reduced income to in part shield fund values, and this will be regularly reviewed to see if more positive changes need to be made in the future.”

Setting aside cash  

Gary Smith, chartered financial planner at Tilney Group suggests that keeping a sufficient cash balance can be helpful, as he says: “We can identify how much income the client needs to withdraw from their pension, each year, over the next three-five-year period. On the assumption that a client has a pension fund worth £300,000, and that they require £15,000 per annum income, they can retain £45,000 in the cash within their pension, leaving the remaining £255,000 to be invested in the markets.

“If markets fall, then the retiree has the option to take their required income from the cash portion of their savings, leaving the investment portion sufficient time to recover. In contrast, if the markets do well, then they could opt to take the growth made to generate their income, leaving the cash fund untouched.”

Not a ‘one and done’process

Whatever action advisers take to address the issue of market fluctuations and other risks, it is an ongoing task: “Income drawdown advice is not a ‘one and done’ process”, says Corliss. “The market outlook remains very uncertain and by committing to regular reviews, advisers have more opportunity to advise small changes to ensure clients remain on track to meet income and expenditure requirements.” 

Fiona Nicolson is a freelance journalist