Pensioners who opted to take income drawdown at retirement, rather than purchasing an annuity, could face a sharp drop in their monthly income as a result of recent stockmarket falls.
Income drawdown is the facility to draw a monthly income from your pension fund while it remains invested in the stockmarket and has been favoured by those with large pension funds wishing to retain control over them while in retirement.
But it is a risky strategy and only recommended for those who have assets, other than their pension, to live off.
This is because the income you can take each year under an income drawdown plan is limited by the taxman to between zero and 120 per cent of what a standard annuity would pay you for your age until age 75.
The amount is re-set every five years when your plan must be reviewed by a specially qualified financial adviser.
Recent stockmarket falls are prompting many drawdown investors to switch from drawdown to annuities because they have seen the reduced level of income they would be locked into for the next five years following a five yearly review.
Those who are worst hit are those who have been taking the maximum permitted income. For example, if the annuity rate for a 65 year old man is 7.5 per cent, you could take a maximum of 120 per cent of this, or 9 per cent.
Assuming a £100,000 fund, that would give you an annual income of £9,000, but if the fund dropped 20 per cent to £80,000, your annual income would fall to £7,800 (9 per cent of £80,000).
In addition, if you continued taking the maximum allowed, your fund could become depleted, particularly if the underlying investments continued to perform poorly.
This is why advisers recommend that pensioners don’t take the maximum income allowed, so that they have some leeway in the event of equities falling in value.
If stockmarkets improve over the next year, you can always ask for a review before your next five yearly one, although your adviser will charge an extra fee for this.
If you can’t stomach further stockmarket volatility or you are approaching age 75 (when income drawdown can’t be taken any more and you have to switch to an Alternatively Secured Pension or buy an annuity), now may be the time to annuitise.
Billy Burrows of The Retirement Partnership says: “The current market conditions show just how risky drawdown can be, particularly for those taking maximum income. But the good news is that annuity rates have been increasing since the beginning of this year as a result of rising bond yields.”
Defaqto pensions principal, Matt Ward, says: “Given the well publicised fact that people are living longer, allied to the current volatility of the investment markets, there is a potential danger that the income drawdown pot will not be able to sustain the client’s retirement needs. If the client is not comfortable with the risks involved, their financial adviser may need to consider sacrificing the flexibility of income drawdown with the stability of an annuity, or appraise the suitability of the new breed of unit-linked guaranteed facilities.”
To see how much your pension fund would buy you, visit our Annuity Calculator:
http://www.defaqto.com/consumer/pensions.aspx
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