Retirees entering drawdown without taking advice need more protection against the risk of seeing their pension savings wiped out by market downturns, industry experts warn.
Calls are growing for the City regulator to impose controls on withdrawals from drawdown funds and introduce new risk warnings, in the wake of volatility that has highlighted the impact of withdrawals from funds that are losing value.
The effect of market falls on drawdown investors has been illustrated by new analysis by annuities specialists Partnership and William Burrows.
It uses the example of a 65-year old man who retired a year ago with a pension pot of £100,000. If he had taken an enhanced annuity he would have a guaranteed monthly income of £542. But if he instead opted for a drawdown fund investing in a FTSE All Share tracker and taken £542 a month from it, he would have seen the value of his pension pot fall by almost 17 per cent.
This is due to the phenomenon of “pound-cost ravaging”, which refers to the impact on a pension when the same level of income continues to withdrawn even as the fund value is falling.
Billy Burrows, of William Burrows Annuities, said: “This analysis highlights the huge risks facing people who choose to go into drawdown while at the same time investing their fund for growth. Although, they have made what may seem to be sensible choices by mirroring the income they might receive from an annuity, market fluctuations mean that in 12 months they have lost over 16 per cent of their pension pot.
“Not only will this be very difficult to recoup if they remain in drawdown but should they choose to purchase an annuity, they will find they have lost a significant amount of purchasing power.”
Those most vulnerable to pound-cost ravaging are pensioners who are unable or unwilling to take financial advice. More than four in ten people entering drawdown plans are not taking regulated advice, Financial Conduct Authority (FCA) research shows.
“Building a sustainable income from a drawdown pot is fiendishly difficult for anyone to do, even advisers,” said Rachel Vahey, Edinburgh-based independent pensions consultant. “There are too many unknowns and too many moving parts, and this makes for a complicated and difficult planning process.”
With the markets outlook uncertain, support is growing for restrictions on income withdrawals.
Jim Boyd, director of corporate affairs at Partnership, said: “Those who purchased these products last year when markets were buoyant and have drawn down since may now find themselves at risk of running out of money prematurely or living a life of poverty in retirement.
“That so many people took this risk without advice is possibly the new mis-buying scandal.”
Drawdown investors won’t suffer because they are “profligate”, said Boyd, but because without advice they are “poorly equipped” to manage the investment, inflation and longevity risks they face.
“It is hard not to imagine there will be a call for safeguards and controls when pension funds which have taken a lifetime to accumulate have been depleted in only a few years,” he said.
Those fears are shared by financial advisers Chase de Vere, which said too many people were taking the risk of running out of money.
Patrick Connolly, chartered financial planner at the firm, said: “Fewer people are buying an annuity despite that, for many, it is the best option. Instead they are withdrawing money from their pensions or going into drawdown, often without taking independent financial advice.”
Drawdown investors increasingly use online calculators to help work out much money they can take from their fund while ensuring it doesn’t run out. But online calculators are misleading because they typically assume consistent investment growth year after year and fail to account for the impact of pound-cost ravaging.
“The calculators don’t usually assume any periods when there will be investment losses, which of course is unrealistic,” said Connolly. “Making your own decisions or relying on online calculators could be a cheaper option, but will prove a false economy if you make the wrong choices.”
While Vahey believes investors should take advice when entering drawdown, she would stop short of making it mandatory. A more realistic option is to introduce stronger and clearer risk warnings so that people go into drawdown with their eyes open.
“We need to get rid of all jargon and put the risk warnings in language everyone can grasp easily,” said Vahey.
“For example, instead of referring to a critical yield, we could include a visual sustainability forecast showing someone at what age their money would run out, and including the likelihood of them being alive at that time.”