Over a million people have taken advantage of the pension freedoms introduced in April 2015, which allow over-55s to take their pensions as cash rather than buy an annuity. However, many are missing out because they do not seek financial advice.
This was the message from the regulator, the Financial Conduct Authority (FCA) in an interim report issued earlier this year, which pointed out some of the mistakes being made, such as moving the monies into inferior investments, paying tax unnecessarily and giving up valuable benefits on the original plan.
To emphasise this point, new research by Hymans Robertson further points out that almost one in three people could run out of money in retirement.
Traditionally, most pensioners bought an annuity when they retired to guarantee an income for life, even after the introduction of “income drawdown”, which allowed you to leave your money invested and decide your own level of withdrawals.
However, since the pension freedoms were introduced, income drawdown has become the default choice for most pension savers. According to the FCA, sales of annuities have fallen by more than 90%, from about 354,000 per annum in 2008 to 30,400 for the year to June 2016. Meanwhile, the take up of income drawdown schemes has risen dramatically. However, the FCA points out that they are complex products and that financial advice and support can be beneficial in most cases.
Whilst income drawdown can offer great flexibility and the potential of an increasing income, it is important that investors understand the risks. As the pension fund remains invested, your future income depends on the performance of the investments selected. If they perform poorly your fund value and potential future income will fall and could run out.
This is particularly the case if you make excessive withdrawals. Whilst the pension freedoms allow you to withdraw as much as you like from your drawdown pension, you could well be eating into your capital, depleting the fund and reducing future potential income. You could also face big tax bills as withdrawing large amounts in a single tax year could push you into a higher tax bracket.
Another recent research study, by Morningstar, suggests that investors who want to avoid the risk of running out of money in retirement may now have to limit their annual withdrawals to just 1.9% of their pot. This is due to high prices driven by booming stock markets.
In the past, many investors followed the ‘4% rule’, a rough guide that implied taking income at a rate of 4% a year would be prudent enough for a portfolio to survive over the course of a retirement. Now, Morningstar advises that an investor with a £100,000 pension pot can only ‘safely withdraw’ £1,900 per annum.
What is clear is that if you opt for income drawdown you need to recognise that you should choose investments wisely and review them regularly to meet your ongoing needs. Financial advice can help in this respect.
It should be remembered that you can split your pension wealth. For example, you could use part of it to secure an annuity income and then move the rest into drawdown to achieve more flexibility. For some, it makes sense to have a secure guaranteed income to cover essential living costs and this could be done via your state pension combined with an annuity and any remaining work pensions. Your drawdown income can then be used more flexibility as additional income for the discretionary pleasures and luxuries of life.
If you are approaching retirement and are looking to take advantage of the new pension freedoms, we recommend that you get some independent financial advice to help with your planning. Why not call Kellands today?