Volatile investment markets may put many people off income drawdown, but Mary Stewart believes it still has much to offer
Robust sales growth in the income drawdown market suffered a setback last year, not surprisingly considering the turmoil on the financial markets and resultant 'flight to certainty'.
Association of British Insurer figures show the generally upward growth path stalled with the number of new drawdown contracts taken out dipping to 29,000 from 33,000 the previous year, and new premiums falling to £2.35 billion from £3.03 billion.
There are several good reasons to believe this will prove to be a temporary blip. Guaranteed annuities are at their most appealing when the sky is falling in but signs of stability - and eventually recovery - will spark renewed interest in drawdown from those keen to take advantage of new opportunities to repair the damage and target future growth.
Flexibility and control
Income drawdown offers flexibility and control over both the assets held within a pension scheme and the way income is taken from the fund. The rapid growth in sales of self invested personal pensions in recent years is strong evidence that pension investors are becoming more comfortable with taking responsibility not only during accumulation but also in retirement.
This has been driven partly by disappointment with the performance of insurance company pension funds, partly by perceptions that annuity rates offer poor value. Many now feel pension investing is too important to outsource and, no longer happy with an 'arms length' approach, they are becoming much more 'hands on'. The greater range of investment choices and extra flexibility are set to make SIPPs the preferred choice of both the discerning pension investor and retiree.
Income drawdown, in simple terms, allows a retiree to draw an income from the pension fund while keeping control of the assets in the fund. These arrangements are known as unsecured pension (USP) up to age 75 and alternatively secured pension thereafter (ASP).
Compared to the certainty that comes with buying the fixed benefits of a guaranteed annuity, drawdown is considered more risky. But the retiree can be as adventurous or conservative with the underlying investments as suits their risk profile. This is one area where drawdown through a SIPP comes into its own, giving access to a universe of assets ranging from shares, managed funds and corporate or government bonds to commercial property, gold bullion and hedge funds. Fixed-return and protected products can also be accessed within drawdown arrangements to mitigate risk and aid diversification.
Death benefits are usually more generous for clients in income drawdown than for annuity buyers. The value of the fund minus a 35% tax charge can be paid out if a client dies while in USP. Under ASP, the fund can be reduced by as much as 82% by the combined effect of charges unless it is left to dependents or charity. For lifetime annuities, the value of the fund will be lost unless protection such as a spouse's pension or income guarantee is in place.
The income available from drawdown depends on the performance of the underlying fund, and also limits imposed to prevent the retiree depleting the fund too quickly. These limits are set by reference to figures produced by the Government Actuary's Department (GAD) based on gilt yields and average life expectancy at different ages. The GAD rate is broadly equivalent to the return the retiree would earn if they bought a single-life level annuity.
Under USP, the retiree can take between zero and 120% of the relevant GAD rate. This gives some flexibility for the retiree to adapt the income to their own requirements, perhaps taking a low income to help bolster the fund or a higher one to pay for a more active lifestyle or aid inheritance planning. Under ASP, the limits narrow to between 55% and 90% of GAD and a quirk of the rules means the retiree is always considered to be aged 75 - the income cannot grow as they continue ageing.
Attempts to fight the economic downturn by cutting interest rates and 'quantitative easing' have pushed GAD rates to record low levels, reducing the income available to those in drawdown. This has sparked interest in alternatives such as scheme pension where the income available is calculated by an actuary based on the size and likely performance of the fund, and the individual's own health and life expectancy. The result is that scheme pension can deliver a higher income than USP or ASP, particularly at a greater age and to those in poorer health.
Drawdown may not come with the guarantees of a lifetime annuity, but it offers more income flexibility, better death benefits and the potential for retirees to continue benefiting from long-term investment and income growth. Perhaps most importantly it allows retirees to keep their options open. Making predictions is a fool's game but those who retain control are perhaps better positioned to continue adapting their retirement strategies to make the best of whatever the future might bring.
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