Billy Mackay highlights the benefits of income drawdown.
Income withdrawal or drawdown pension remains a popular retirement option despite a number of high profile policy and regulatory issues that seem to be hogging the headlines.
Topical areas of debate seem to be centred on continued regulatory pressure and the calls for changes to the rules for calculating maximum income.
The regulatory focus on this market goes back many years but the themes identified over the years since 1995 seem to remain consistent. I was clearing out my office recently and found copies of old PIA updates 55 and 67.
Reading them again showed that update 67 included findings from a review where the conclusion was that there was little evidence of a systematic failure to give suitable advice. However, due to poor record keeping no conclusions could be reached on whether or not:
• Firms were providing an adequate explanation of the inherent risks of opting for income withdrawal rather than the other options available.
• The advice given by firms complied with the standards set out in the PIA's Rules.
It was concluded that the risks of this environment were often described in a superficial manner and in terms that the investor would not have been likely to understand. The risk warnings that were highlighted were that:
• High income withdrawals may not be sustainable during the deferral period.
• Taking income withdrawals may erode the capital value of the fund, especially if investment returns are poor and a high level of income is taken. This could result in a lower income when the annuity is eventually purchased.
• The investment returns achieved may be less than those shown in the illustrations.
• Annuity rates may be at a worse level when the annuity purchase takes place.
If you look at the FSA website today you will find that, by and large, the same risks are identified as key for advisers to focus on. FSA guidance also makes it clear that drawdown is viewed as riskier than an annuity as the income received is not guaranteed.
I have to admit that I have always taken the view that the nature of the risks are different and determining whether one is riskier than another depends on the circumstances of the case in question.
Many years ago I worked in an actuarial department for a provider that offered annuities. I will never forget a scenario where a client with a £1 million plus fund bought an annuity with no spouse's pension and no guarantee period and died after a single annuity instalment. Good news for the mortality pool but not such good news for the surviving family.
A case for change
As a business we have nailed our colours to the mast and continue to lobby for changes to the rules for calculating drawdown maximum income with our main theme being a call for the Government to:
• Immediately re-instate the 20% uplift on drawdown calculations which was removed from 6 April 2011.
• Carry out a policy review as to whether slavishly following gilt yields and actuarial principles remains the most appropriate way to set drawdown limits.
The income drawdown market has evolved in many ways over the last 17 years. The benefits that attracted people to it remain true today i.e. control of the underlying pension fund income, timing of annuity purchase and death benefits. The many events experienced since its launch mean we now understand how this particular vehicle behaves in all kinds of market conditions.
More than ever, clients are using income drawdown as part of an overall retirement strategy. The market is driven almost entirely by clients under the guidance of an IFA.
Strategies for how you invest and draw income are common. Clients will know whether their pension plan is likely to be their primary source of income. They will be provided with information to outline the overall resources that they will have and need in retirement.
They must consider the rate at which income is likely to be taken from the fund allowing for market conditions, the likely investment performance of the portfolio and the charges levied by the product provider.
This is why the SIPP and platform markets remain a very popular choice for advisers active in this area.
In my experience, we are now better at articulating what all of this means to the end client. We can't always influence Government policy or market conditions.
However, it remains a popular choice because we can influence income levels. We can take decisions about the appropriate and acceptable level of risk and sit this alongside a sensibly structured investment strategy with regular reviews.
For many investors, those benefits continue to provide more than enough reasons to buy.
Billy Mackay is marketing director at A J Bell
Risk to retail investors
Joined as head of strategy, multi asset, in June
Group income protection