FLEXIBLE DRAWDOWN

The introduction of flexible drawdown regulations was greeted by the pension industry as a progressive landmark in encouraging investors to save, but will the additional options simply make planning your retirement more confusing?

Since April, the requirement to purchase an annuity by age 75 has been dropped.

While you are still able to buy an annuity from the age of 55, new regulations will allow you to use income drawdown instead, through either:

• Capped Drawdown: where you invest some or all of your pension savings in an arrangement with no age restriction and a withdrawal cap of 100 per cent of what you would have received from an equivalent annuity, or

• Flexible Drawdown: where you can draw out unlimited amounts from your pension pot, provided you can demonstrate you have a secure income of at least £20,000 a year for the rest of your life. 

Some commentators are huge proponents of the changes.

Adrian Walker, head of retirement planning at Skandia, says that with the changes linked to the wider new Income Drawdown rules, he expects more people to delay their annuity purchase in favour of using income drawdown.

Skandia’s recent Adviser Confidence Barometer suggested one in five advisers (18 per cent) thought income drawdown was appropriate for more than half their clients.

The majority (59 per cent) believe income drawdown is currently appropriate for between 10 to 30 per cent of their clients. Risky business Investors should be cautious, since the more flexibility you take advantage of, the more you will be exposed to income-related risks during your twilight years.

It is unlikely that a large proportion of pensioners reaching retirement will be able to make use of the minimum income requirement (MIR), currently pegged at £20,000 a year for life.

The government believes just 50,000 people currently in drawdown are likely to be able to afford to secure the MIR. Statistics from the Association of British Insurers show around 250,000 people currently have income drawdown accounts.

‘We would not typically recommend income drawdown for a client with a pension fund smaller than £100,000, although this is usually because investors with smaller pension funds tend to be more cautious and not have other sources of income in retirement,’ says Martin Bamford, chartered financial planner with Income Choice.

‘In addition to pension fund size, we would look at income levels, the level of risk an investor was prepared to take and other sources of income.

There is also a strong case for a mix and match approach; securing a base level of income through annuity purchase and then leaving the rest of the pension fund invested using income drawdown.’ Products also tend to be expensive.

Daniela Silcock, senior policy researcher at the Pensions Policy Institute, said the Treasury estimates drawdown costs to total around 5 per cent of the initial fund value, taking into account ongoing management charges and advice.

‘Those who do make use of capped drawdown may run more risk of depleting their funds during retirement than they would have if they had been compelled to buy an annuity, because drawdown accounts do not provide protection against market fluctuations,’ she explains.

‘However, the requirement for those in drawdown to undergo investment reviews every three years, and annually once they are over the age of 75, could help mitigate this risk.’

Income Choice’s Bamford also warns that there isn’t just the risk of running out of money to contend with. Continued investment risks mean the value of your pension fund can fall as well as rise, and maximum income limits, as prescribed by GAD (Government Actuary Department) rates can fall and restrict the amount of income you can access, he says.

‘Finally, as you get older you need a greater investment return to keep pace with the equivalent benefit you would have received if you purchased an annuity instead.

'All of these risks should be quantified, explained and understood before using income drawdown.’

• Charlie Thomas is executive editor of Pensions Management magazine.