Riding the Ups and Downs of Drawdown
Retirement isn’t just about making the right pension choices – it’s about making the right choices at the right time. If you don’t know whether to take the plunge into an annuity or a drawdown scheme, then two of the biggest factors will be preparation and timing.
For many new pensioners, the start of pension freedom has been a turbulent one. Ever since it became possible to leave one’s pension pot invested in the stock market and draw income from it as required (known as drawdown) a lot of people are doing just that. But just because you can do something, doesn’t mean you should.
In the six months following the start of pension freedom, more than 43,000* people took out drawdown schemes – causing drawdown to overtake the annuity in the popularity stakes for the very first time (just 40,600 annuities were sold in the same period). In that time pensioners collectively made 606,000 drawdown withdrawals, with the average payment being £3,600.
However, the poor stock market performance back in 2015 gave pensioners 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. Any money taken out of the funds would have exacerbated the problem for pensions, and in less than a year many would have seen the loss of nearly a tenth of their pension pots.
This sort of mini-crisis can occur at any time when you have a drawdown scheme, and it can trigger 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 in advance.
Pension choices are something to think about years in advance – 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.
(Diversify, diversify!) 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 bought an annuity between July and September 2015 simply took the first one offered to them. A good decision taken down could save you thousands of pounds over the course of your retirement.
Seek independent advice
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.