Updated 19 May 2022
Poor stock market performance has hit investments hard over recent weeks. This can be a real problem if your pension is in a drawdown scheme. Find out how the market might affect your retirement income - and what you can do about it. Article by Nick Green.
When you retire, you have a choice about how you take your pension. The two main alternatives are either a guaranteed income for life (which can't run out, but might not be very much) or a flexible income (which you can increase as need, but which can run out). The first type is known as an annuity, and the second type is drawdown.
Drawdown means your pension pot is left invested in the stock market, for you to draw income from it as required. However, this means it remains affected by stock market movements. When pension freedom was introduced in 2015, more than 43,000* people took out drawdown schemes – but poor market performance gave them a baptism of fire. According to Retirement Advantage, the average drawdown fund lost 8 per cent in the six months following April 2015, based on equity, bond and cash returns. Even worse, taking money out when the market is falling only makes the problem worse, and in less than a year many would have seen the loss of nearly a tenth of their pension pots.
Now in 2020 in the grip of the coronavirus scare, the same sort of thing is happening again. The FTSE All-Share index has lost a lot of ground over recent months, so anyone drawing money out of their pension is depleting the fund at a faster rate than is desirable. the result is a real rollercoaster ride for pensioners, who yet again have to see their fund shrinking by thousands of pounds more than they bargained for. This unpredictable volatility is the single biggest hazard of drawdown schemes.
If you're in this position, you face a dilemma. You don’t want to move your money out of the drawdown fund, because this would ‘crystallise’ the losses (make them permanent). But neither do you want to draw an income and deplete it further until it starts to recover again. This might leave you in the absurd position of feeling you can’t use your pension pot to fund your retirement – at least not yet. What can you do?
If this happens to you (as it very probably will at least once or twice over the course of your retirement), then your first priority should be minimising any losses. If you can, reduce the amount you are withdrawing from the fund (or stop altogether if possible) and use other sources of income if you can. Drawing income from a falling fund makes its fall accelerate, but if you can ride out the storm, your untouched fund should recover more quickly.
When the stock market has recovered and your fund is looking healthier, you can take steps to ensure that future market dips don’t affect you so badly. Talk to a financial adviser about the structure of your fund and possibly moving to a less risky portfolio. Nearly half (42 per cent) of people who took out drawdown funds did so without taking independent advice, and many may have funds that are riskier than they realise (e.g. invest entirely in equities with no cash or bonds for stability).
If you haven’t yet made your pension choices, you can minimise the risk of getting into this position by taking some simple precautions .
Pension choices are something to think about years ahead of time – not in the last month or the last minute. If you delay your decision until the moment you have to take it, you may find that it’s the stock market that dictates your course of action, not you.
If you want more room to manoeuvre, the best time to plan is ten to five years from retirement. By then you’ll have a good idea of your needs in retirement and the likely size of your pension pot, so can start to think about which options will suit you best (e.g. lump sums, an annuity, drawdown or some combination of these). You can then arrange your pension investment to be best suited to your retirement plan. For instance, you could progressively move your equity investments into safer securities and/or cash. This kind of advance planning can put you in the strongest possible position whatever the stock market is doing at the time you want to take your pension. This means that you, not the market, will remain in control of your decision.
The more options you have, the less likely you are to be cornered. It’s best to build multiple options into every level of your retirement plan, from the structure of your funds to the choices you make. So if you have a drawdown fund, ensure it’s in a good mix of investments. Similarly, you may not want to rely wholly on your drawdown fund – if the stock market is falling and you need to leave your fund untouched, what other sources of income could you use? Some people choose to have an annuity running concurrently with their drawdown scheme, so that they always have a minimum guaranteed income.
Statistically you are very unlikely to get the best deal from your current pension provider, whether you’re after an annuity or a drawdown scheme or both. FCA figures show that almost two-thirds of people who buy annuities simply take the first one offered to them. A good decision taken down could save you thousands of pounds over the course of your retirement.
The choices you make concerning your pension are life-changing and often irreversible. There is no more important time of life at which to seek the help of an independent financial adviser. An IFA can ensure that you make the right choices at the right time – no matter how well or badly the stock market is behaving.