‘Risky’ income drawdown is becoming increasingly popular as annuity rates offer disappointing returns
SCOTS who left their pension pot invested when they retired have been given a New Year boost with an increase in the income they can take from their savings.
The rise in the maximum that can be taken from income drawdown took effect last week and came as more people look for alternatives to taking out an annuity when they retire.
Annuity rates are on a long-term downward trend, although there were improvements over the last year. And with concerns growing that too many people are being shortchanged by annuity providers when they retire, options such as income drawdown are increasingly popular despite the extra investment risk they entail.
Drawdown allows the fund to be left invested at retirement and income taken from it in segments. There are two forms: flexible, where investors meeting certain criteria can take as much income from their pension as they want; and capped, where the amount that can be taken each year is limited.
The government last year restored the maximum that can be taken from capped drawdown to 120 per cent of the value of the equivalent annuity – the Government Actuary’s Department (GAD) rate – having previously cut it to 100 per cent.
The initial reduction was designed to prevent pensioners from using up their savings prematurely, but the maximum was raised again following a plunge in gilt yields that meant some retirees saw their income slashed by more than half.
And the amount that can be taken from drawdown increased again last week when the GAD rate jumped from 3 to 3.25 per cent.
The change means that a 65-year-old who has a pension fund worth £100,000 can take up to £7,320 from their pension pot this year, up from £7,080 last year, according to LV=.
Many face a wait until they can benefit, however, as drawdown levels are typically reviewed every three years (or annually for those aged over 75).
That is beginning to change, with Standard Life last year introducing a drawdown transfer option allowing people switching their pot to the Edinburgh-based firm to trigger an automatic review of their income level.
It’s not always a good idea to take the maximum amount from your fund each year, however, and it’s likely to mean your income will be lower later in retirement.
But with questions growing over the value of annuities, more savers are looking into drawdown as an alternative.
Financial advisers reported a steep increase last year in the number of people asking about drawdown rather than automatically buying an annuity.
“Drawdown is a high-risk product primarily suitable for larger funds and people with a range of alternative income sources,” said Graeme Mitchell, managing director of Borders IFA Lowland Financial.
“However, if you understand and accept the various risks, I believe drawdown is an excellent way to keep open all options for income at retirement.”
An annuity is your best option if your pension is likely to be your only or main source of income during retirement (aside from the state pension).
If you have other income to fall back on and want more flexibility, however, drawdown may be suitable for you – provided you understand the risks.
“You have to appreciate that future income could be less if you have more at the outset or if markets are volatile, particularly at the start of your retirement,” said Mitchell.
“That’s why it’s so important to have alternative sources of funds – if markets result in a fall in the pension fund it may be sensible to defer income for a year or two, but if the pension is all you have you can’t do that.”