Pension freedoms removed the compulsion for pensioners to buy an annuity and transformed the way people aged over 55 can choose to access their retirement savings.
It was a huge victory for individual choice, however greater freedom has introduced an element of risk, that, without proper preparation and advice, threatens to leave people with little or no income to carry them through their later years.
People were already facing the prospect of a longer and more varied retirement, putting greater strain on financial, physical, social, and cognitive resources, but the freedoms have added further complexity to the task of ensuring retirement is well provided for.
Today, the decision to retire comes at a time of economic change. The UK’s decision to leave the EU introduced a further round of financial instability, while the prospect of rates rising sharply soon appear remote.
The low interest environment has spurred pensioners to look for riskier options in retirement. Drawdown is likely to continue to emerge as the more popular source of pensioner income for the foreseeable future, particularly for those who want both capital growth and regular income.
This alternative route, brought to the foreground by the 2015 pension freedoms, is an attractive one for a couple of reasons. First, allowing an individual to decide how much to take from their pot each year gives that person the flexibility to adapt their income to suit their changing financial needs in retirement.
Second, it does not close the door to investment returns, so strong investment performance could lead to a larger pot and the availability of yet more income.
However, there are some quirks of income drawdown that can make living off investments in retirement challenging. They place a huge amount of emphasis on market performance for determining future income potential and are amplified by the impact of regularly withdrawing money from a pot in the form of retirement income.
Financial markets are volatile, and are subject to both falls and rises. The very effect of market volatility will likely mean a person’s portfolio will have to work harder. For example if a £100,000 pot falls by 10 per cent in the first year of an investment, that £90,000 needs to grow by 11% to return back to £100,000. If that person is withdrawing money at the same time, it makes it even harder for the pot to climb back up to its previous highs.
The very same goes for market timings and the order, or sequence, in which market fluctuations occur. For example entering the market just prior to the fall seen in 2001, and then again in 2009, would reduce a pot to such a level that any subsequent market climbs wouldn’t have the same positive impact retirees would have enjoyed if the market climbs occurred prior to the falls. Again, the effect of withdrawing money serves to amplify this, so a protracted fall in early retirement, coupled with an unsustainable rate of income withdrawal, could derail an entire retirement plan