The new pension freedoms sent the strongest message yet that more Britons need to embrace income drawdown. We look at the top five ways to tell if it’s right for you.
First things first, what IS income drawdown?
Income drawdown is a way of using your pension pot to provide you with a regular retirement income by reinvesting it in funds specifically designed and managed for this purpose. The income you get will vary depending on the fund’s performance.
Here are our top 5 ways to tell if its right for you:
1: You’re one of those people who feel that a pension pot of £100,000 should do a bit more than just deliver £50 a week in income and then disappear altogether when you die (!)
Unfortunately, this is pretty much what a £100,000 annuity buys the average 65 year-old these days1. As pension expert Neil Adams of Drewberry Wealth explains, “Traditional annuities aren’t just perceived to be worst deal of the century; they’re often viewed as the worst deal for the last three centuries or more. Super-low interest rates and the never-ending rise in our lifespans has ‘scuppered’ annuity rates,” he says.
In years gone by, ‘retirement’ generally meant taking your 25% tax-free cash and using the balance of your pension pot to buy an annuity that would provide a steady income for the rest of your life (about seven years or so back then!). But the world has turned.
“Fortunately,” says Adams, “the arrival of ‘flexi-access drawdown’ as part of 2015’s pension freedoms addressed the issue,” he says. “If used wisely, income drawdown can deliver much more income than an annuity, better tax efficiency and still preserve your pension pot so there’s something to leave to the next generation.”
Drewberry calculated that, based on modest annual growth of just 4%, a 65-year old who elected to ‘drawdown’ the same £2,570 a year paid by an annuity would still see their pot grow to be worth just shy of £138,000 by the time they were 83 (their current ‘expected’ life span).
1 Based on open market annuity rates available as at 23 May 2017, provided by Drewberry.
2: You have children or other loved ones who you’d like to pass your pension savings along to rather than just giving them to an insurance company…
As strange as it sounds, this is exactly what happens to a great deal of the accumulated pension wealth in this country – it just goes back to insurance companies. Although millions of Britons still rely on annuities, once they die, these annuities will disappear. Once again, the pension freedoms came to the rescue, this time by abolishing the hefty 55% ‘death tax’ on any pension savings you leave behind.
As Adams explains, “This made the personal pension one of the most tax-efficient ways to pass wealth down through your family and helped to trigger the current landslide in final salary pension transfers,” he says.
3: You recognise how much your pension pot has already benefited from investment risk over the years and that you’ll need to keep on taking some risk if you want to optimise your retirement income
Make no mistake, the big difference between income drawdown and the alternatives is that the investment risk sits squarely on your shoulders.
But, as Neil Adams observes, “In an era where the average Briton has something like 11 jobs during their working life, most of us have come to terms with the fact that we need to take care of our own retirement.
“Income drawdown shouldn’t be a great shock to the system for the coming crop of retirees,” he says. “It just means you keep your pension pot invested throughout your life rather than ‘cashing it in’ for a measly annuity at some arbitrary age.
“Most people recognise how much they’ve already benefited from being exposed to stock markets over the long term,” he says, “and income drawdown is an extension of this. It comes down to putting a robust investment strategy in place that can deliver the income you need and still, hopefully, grow in real terms.”
The biggest risk is that your portfolio performs poorly while you’re drawing an income. If left unchecked, your pension pot could meet its end before you do – a fate colourfully known as ‘pound cost ravaging’.
To help prevent retirees being ‘ravaged’, you can use Drewberry’s online drawdown calculator – a free tool that illustrates how much income you can afford to take, how long your pot will last or how much you’ll need to squirrel away to enjoy your ‘dream’ pension income.
4: You’d like to pay less tax in retirement and you recognise that the flexibility that comes with income drawdown could help you do just this
Being in control of the income you take from your pension pot gives you a better chance of limiting the tax you’ll pay – something that’s much harder to do if you’re on a rigid fixed income.
As Adams explains, “Adjusting your income or taking tax-free lump sums can keep you in a lower tax bracket, which will be a major saving. The precision control that income drawdown offers also makes it easier to utilise other tax allowances,” he says. “Couples who use their allowances carefully can enjoy a tax-free retirement income of over £60,000 a year – and that’s before anything they might draw from ISA savings,” says Adams.
5: You’re happy to pay for a little navigational advice while you’re plotting your own course through retirement
The biggest adjustment that’s needed for income drawdown is one of mind-set. “You need to realise that the ‘race’ doesn’t suddenly end when you reach your target retirement date,” says Neil Adams. “Most of us will need to know just how long our pension pot will last,” he says, “and we’ll need some solid investment guidance to stop us depleting our pension pots before we’re finished with them.”
The need for genuine investment insight, the blinding array of drawdown charging structures and the minefield that is the UK tax regime, mean that it’s well worth parting with some fees for regular professional advice.
“The savings that most advisers can deliver mean that good advice more than pays for itself over the course of your retirement,” says Adams. “Income drawdown is a brave new frontier for retiring Britons,” he says, “but not one you should explore alone.”