Research we have carried out with Sippdeal investors has demonstrated that many view the decision on choosing how to take your income from your retirement savings as one of the biggest you will take.
With a variety of options available, knowing what each option does, how it might work for you, and the risks involved will help you to choose the most suitable path.
This article focuses on one of those options - drawdown pension, also known as ‘capped drawdown’. However before looking at that option in detail it is worth mentioning that the other popular option, a lifetime annuity, will be the right option for many. As we consider below, drawdown offers you flexibility in terms of the income you take, hopefully the chance to see your funds grow and control of the pension should you die. What drawdown doesn’t offer is the security of a guaranteed income for the rest of your life. That is what you receive if you choose an annuity, and that security is important to many retirees.
Drawdown offers you the option of leaving your funds invested whilst you draw your pension, rather than handing your pension over to an insurance company who will pay you a guaranteed annuity in return. The continuing investment of your drawdown funds after you’ve started to receive a pension hopefully means that you will continue to see your pension grow in value.
Of course, because your pension is being taken from a fund that is often exposed to the stock market, you also have to consider the risk that your investments may fall in value.
Drawdown investors can vary how much of their pension fund they want to take as an income each year, subject to a Government set maximum. There is no minimum income so, having taken their 25% tax free lump sum, if they have other income sources or want to live on the proceeds of the tax free cash, many choose to take no pension for the first few years of drawdown and just let their pension fund grow.
The maximum pension is based on rates set by the Government Actuary’s Department and will vary depending on how much a pension fund is worth from time to time. The maximum is also based on returns from gilts. However, after extensive lobbying from providers that included Sippdeal this is currently under review.
It isn’t usually considered to be sustainable to take the maximum drawdown for a prolonged period, because the level of income you take, together with your investment performance, will affect the maximum income you can take in the future. Putting it simply, if you take too much out, your maximum income may drop in the future. This drop can be substantial if your investments don’t perform, so you need to keep on top of how your pension fund is performing and adjust your income accordingly. The freedom to adjust the income you take is seen by many as a positive of drawdown. It’s worth remembering that you can’t control Governments, you can’t control stock markets but you can control the rate at which you take the income from your pension fund using capped drawdown.
You’ll also need to consider that annuity rates aren’t guaranteed and that they may not be as good at any given future date if you want to buy an annuity.
It used to be said that drawdown products were only suitable for individuals with a pension fund worth more than £100,000. Charges were a factor, but investment platforms now offer lower-cost access to drawdown. Another reason was the need for a cushion against the risk of investment loss. This is still important, but with many individuals now able to draw a retirement income from a variety of pension and non-pension assets, the most relevant factor is the combined value of assets which can provide a retirement income and the security of the income they can provide.
Any investor considering drawdown must appreciate how drawdown works and the risks involved. Whichever option you decide to take, ensure that you thoroughly research the various options available. The many options available should be viewed as a positive but as with any financial decision an informed decision is often a good one.