This article is the third in a series of articles, written in conjunction with the Financial Times' Next Act hub. It takes a look at some of the financial issues affecting those in their 50s and is sponsored by Canada Life.
For many people approaching retirement, there is a sense of dread when it comes to navigating the rules about accessing their pensions.
Pension drawdown has grown in popularity since 2015. It enables savers to take a tax-free lump sum from their defined contribution pension, but keep the remainder of the money invested to provide an income during retirement.
Currently, three times the number of savers are opting for drawdown plans than those who are buying annuities, according to the Financial Conduct Authority.
However, it is vital that retirees understand the risks. A few wrong moves and over-55s could be left with next to no income in later retirement — or it could be that they are too cautious and surrender having a comfortable later life when they do not need to.
According to Tom Selby, senior analyst at AJ Bell, there are risks associated with all retirement income routes, but drawdown is a particularly complicated system to navigate due to the variety of risks and the flexibility that is on offer.
“Arguably the biggest danger in drawdown is to people who plough on regardless of any investment hits and just hope for the best,” Selby says. “You need to be flexible and prepared to adjust your income in order to ensure your strategy remains sustainable.”
So what exactly do savers need to look out for when accessing their pots?
One of the biggest risks with drawdown is running out of money. Savers can exhaust their pot more quickly than expected if they take income at an unsustainable rate, have insufficient growth from their assets or experience “sequence of return” risk — where market falls and heavy withdrawals early in a person’s retirement limits the longevity of their funds.
But the list does not end there. Some people will be too cautious managing their investments and take too little income, meaning they leave a massive pot behind.
There is also longevity risk, which occurs from people underestimating their life expectancy, and the risk of incurring a hefty tax bill by taking too much income, or being snared by the money purchase annual allowance (MPAA) if they take pension benefits, then continue to add to their pot.
According to John Waldie, managing director at Atkins Ferrie Wealth Management, stock market crashes have been the biggest issue for his clients.
“If we take the Covid crash in March last year, clients’ assets could have fallen by 20 per cent quite quickly and taken until October to recover,” he explains. “Continuing to draw income in this environment would have required proportionately 20 per cent more assets to be sold to produce the same income.”
He ensured his clients held a minimum emergency cash reserve, separate from their pension, and recommended they stop drawing from their pot until markets recovered.