Flexi-access drawdown in retirement is a welcome new freedom but works best for people who are financially disciplined or who are receiving good advice. When stock markets around the world are volatile, it’s tempting to overeact and sell after setbacks, but investors should try to avoid this.
History shows the biggest gains often occur immediately after a crisis. And there’s an upside to this too. For anyone who can afford to grow their fund, falling share prices offer opportunities to buy at often bargain prices.
Drawdown is a long-term commitment that needs careful planning. So what is the right approach in uncertain times?
Managing expectations and understanding risk is vital. This is where a good financial adviser can educate clients on the pitfalls of the global stock market and the importance of a long-term attitude and a balanced portfolio. When an investment declines in value, maybe 5 or 6 per cent in a year, what is the pensioner’s reaction? If the first instinct is to panic and blame the adviser, then that person should not have a big exposure to the stock market. If someone is more sanguine about short term volatility, then stocks are appropriate as part of a diverse basket of assets.
The importance of spreading assets across shares, government and corporate bonds, cash and property cannot be over-stated. Pensioners are better protected against stock market falls if their retirement income isn’t riding on the performance of one sector or stock. I also recommend they keep at least one year’s income in cash for quick access.
In financial planning, regardless of how much income pensioners are drawing down, it is important to do it in a tax efficient manner. The income is being taken from a tax-free environment to one where tax is due, although if the available tax free lump sum has not been taken previously, 25 per cent of what is taken is without income tax. I notice many people request to take money from a pension pot to then hold this within another investment vehicle as soon as they can. Sometimes it’s because they fear future changes to pension rules, sometimes it is to repay a mortgage or simply because they just want to have the money as they retire. In a volatile market this can be a bad idea. It’s true, that in some years the capital will fall in value, but it will often recover. The losses are only on paper,
after all. If capital drawdown is managed well, higher rate tax can often be avoided altogether which is more difficult to do in another investment vehicles without the tax free portion. I find people are resistant to the idea of paying higher rate tax as retirees, more so than when they were earning.
So in what ways can the tax bill be minimised? First, plan big ad hoc expenditure like cars and holidays and access your immediate and future requirements against your cash and pension resources. Also review your day-to-day expenses and ultimately don’t take more from your pension that you need and ensure that you consider using other savings for larger purchases too. Work out if you are going to take an annual sum, regular monthly sums or ad hoc lump sums. What everyone hopes to avoid is a stock market downturn just before an investor needs to take a large cash sum.
They will be badly affected because their money suffers a double hit from the withdrawal itself and falling investment values. At these times, savers should reduce or stop withdrawals altogether until the market recovers. But having said that, the stock market is a long term investment and can be expected to outperform cash savings over a 10 year period.
Pay more in
If anyone is still earning or working part time, then it may be a good idea to invest more into their pension, buying bargain stocks, for example. This can allow the pension provision to be boosted further although savers should review the rules regarding annual allowance and money purchase annual allowance to ensure that they are able to contribute further to a pension and to what level.
The overall size or equivalent value of the pension provision needs to be reviewed also as those with larger pension pots could pay increased tax on income or capital withdrawn if the lifetime allowance is exceeded.
Attitudes to risk
Most of my clients accept moderate risk levels which means they do not want to be overly exposed to the global stock market. For risk averse clients I recommend only 20-25 per cent of their fund is in equities and for those able to tolerate medium risk, no more than 50%. Even a person with very high tolerance should not have more than 85% of their pot in equities. Ironically, often risk averse people are over-exposed to the stock market without realising it. They may have their pension invested in one famous fund, which is entirely based on stocks. Even a “balanced fund” comprising equities, bonds, property and cash is higher risk than they may realise because it has only one fund manager.
For most people, a pension should be invested across 20 or more carefully selected funds that include diverse asset classes. And this profile of funds will be aligned to the client’s risk tolerance and regularly reviewed and changed over the medium term to maximise yield. For example, in a fluctuating market, some investments can be moved from equities when stocks are rising and held in cash ready to invest when the market falls and stocks look cheaper and a better long term investment.
MorningStar, a fund analyst, assesses 4,400 different funds worldwide for suitability for each kind of client risk profile. Furthermore, clients change their attitude to risk over their lifetime and that is why management of a pension should accompany life and legacy planning too.