Large numbers of savers are making basic mistakes that will cost them dearly later in retirement, experts have warned.
Data published by the Association of British Insurers (ABI) on the first full year since the “freedom and choice” pension reforms of April 2015 found that while most people are being sensible, others are taking significant risks.
The research underlined the popularity of drawdown, where the pension is left invested and income taken from it in tranches. But large numbers of people are entering drawdown without taking advice, despite the complexity of the products, while too few savers are shopping around for either drawdown products or annuities.
For all the advantages of the reforms, too many people are falling into the traps hidden in the rules. Here we look at some of the issues highlighted by the latest data.
1) Make it last
Most savers are being sensible, judging by the ABI data, with 57 per cent of pots having 1 per cent or less withdrawn from them in the first three months of 2016. But more than 4 per cent of pots had regular withdrawals of over 10 per cent each quarter and a fifth of people are taking 8 per cent of more from their pensions each year.
If you take 10 per cent every three months from a £100,000 pension pot, it’ll be gone in less than three years.
The accepted wisdom is that 4 per cent is a sustainable level of income to take from a pension. But research by Morningstar, the investment analysts, suggests that investors in the UK would be safer sticking to income withdrawals of 2.5 per cent.
“In a low interest environment it is difficult to get more than 4 per cent income from savings and investments, which means that people are drawing down on their capital as well as taking the income,” said Adrian Lowcock, investment director at Architas. “This is unsustainable as over time these retirees will need to draw the same income from a smaller pot.”
The impact of withdrawals on pension savings is exacerbated by “pound cost ravaging”, which is what happens when the same level of income is taken even as the value of the pot is reduced by market volatility.
2) Don’t go it alone
The risk of pension pots being drained prematurely highlights the importance of taking advice. Just six in ten drawdown customers took regulated advice, according to research earlier this year by the Financial Conduct Authority (FCA), despite the complexity of the arrangements.
“I would argue that drawdown should only be made available with advice,” said Iain Wishart, owner of Wishart Wealth Management in Edinburgh. “Drawdown plans require special care, skills and attention, including an ongoing drawdown investment and income strategy. Few retirees are equipped to set up or monitor drawdown.”
Royal London Intermediary figures show that its customers, who must take advice when entering drawdown, withdraw an average of 2.62 per cent, less than half the 5.63 per cent average withdrawal recorded by the ABI.
Fiona Tait, pensions specialist at Royal London, said: “We believe this is due to advisers helping their clients to understand how much they can realistically withdraw without running out of money in the early years.”
3) It’s not either/or
While drawdown becomes increasingly popular, sales of annuities, which provide a guaranteed income through retirement, continue to fall. The trend is likely to accelerate as annuity rates are dragged down by tumbling gilt yields, potentially pushing more people towards the risk of drawdown when annuities might be more suitable.
But those eschewing the certainty of annuities in favour of drawdown might be missing out on a better solution – a combination of the two.
“With income much harder to come by and markets at a surprisingly high level a combination of annuity and drawdown is likely to be a good option these days for many people,” said Graeme Mitchell, managing director of Lowland Financial Planning in Galashiels. “Annuity rates may seem poor value at around 5 per cent a year, especially when your capital has disappeared, but they provide a secure dependable income at modest cost – impossible to find elsewhere.”
Wishart said: “There is a strong case to add guaranteed annuities to other sources of income, such as state pension or defined benefit pension, to ensure the base costs of living are met whatever happens,” he said.
One option is to take a 30-year annuity, which offers around 4 per cent a year and ensures the payments go to beneficiaries on the policyholder’s death.
Another is a temporary annuity that can provide a high annual income for a certain number of years, which can be especially useful if you don’t want to rely entirely on your drawdown funds for your income.
“This can be used as a kind of back-to-back arrangement where you take a secure temporary income for, say, five years and invest the balance for growth till the annuity income stops, in the hopes of growth to replace the fund used to buy the annuity.”
4) Shop around
You’ll likely get a better deal from your drawdown plan or annuity if you look at other options instead of taking the first offer from your existing provider.
The FCA has said that for risk-averse savers with average-sized pensions, annuities usually offer better value – provided they are bought on the open market. A 2014 review by the regulator found that eight in 10 of people who took the annuity offered by their existing provider could get a better deal on the open market, but the number of people shopping around for their annuities has fallen since April 2015.
The figures from the ABI show that just 41.5 per cent of savers switched when buying an annuity and just 53 per cent moved to a different provider when entering drawdown.
Andrew Tully, pensions technical director at Retirement Advantage, said: “The shopping around process continues to fail, and less people are actually looking for a better deal since the start of pension freedom. This leads to poor value whether people are choosing drawdown, annuity or a blend of both to provide their retirement income.”