Income drawdown can be a convenient way to access pension savings, but there are also potential downsides.
So, what are the risks associated with drawdown and how should advisers best manage these?
Henry Tapper, executive chair at AgeWage, says: “There are two principal risks – firstly, drawing down too hard, with the risk of running out of money and secondly, not drawing enough to enjoy retirement while you can.”
Tapper points out that as well as taking too much risk, too little can be an issue too: “Models suggest that there are risks from an overly conservative investment strategy. Advisers should therefore explain risk and reward through worked examples.”
Gavin Jobson-Wood, specialist business development manager at Scottish Widows, says: "A formalised retirement advice process ought to incorporate a thorough analysis of a client’s expenditure requirements in retirement, taking into account their capacity for loss. As a consequence, the most appropriate method of generating income may not always be flexi-access drawdown."
He adds: “Liquidity can also be a risk on drawdown, especially where investments are in infrastructure, property and in unquoted stocks and bonds.”
Financial planner Jon Young at WealthFlow takes a similar view: “The biggest risk with drawdown is running out of money. Everything else is secondary because when the pot is gone, it is gone and you are left reliant on state benefits, which are designed to cover only the most basic of outgoings.
“The best way for advisers to tackle this risk is through the use of a centralised retirement proposition. This should set out automatic changes to the investment strategy, such as de-risking or the benefit of holding more cash in comparison with the inflationary risk of doing so once a client starts drawing down on their pension. They should also check the sustainability of withdrawals.
“With the old ‘4 per cent rule’ largely dead, consideration should move to using cash flow and stochastic modelling to gauge sustainability. Furthermore, advisers need to consider how much basic income should be covered through a guaranteed source for each individual client; it does not have to be drawdown or an annuity, it can take the form of drawdown and an annuity.”
Catriona McCarron, wealth manager at Ascot Wealth Management, reflects on the wide range of drawdown risks, as she explains: “Drawdown comes with multiple risks, such as investment risk, longevity risk and the less obvious risk of having flexible access – the ability to dip into the pension pot as you would dip into an Isa, for example.
“The risk here is getting complacent and withdrawing capital that could impact on the affordability of designated income drawdown in the future. Advisers should use appropriate suitability letters and risk warnings when addressing drawdown objectives with a client, so that they understand this risk.
“Advisers should also manage client expectations and advise on realistic and sustainable drawdown figures. In addition, they should use cash flow modelling to provide insights into the client’s capacity for loss, the pot’s reaction to a financial crash, or for how long the client’s existing level of income is affordable.