Anna Sofat talks through the advice issues thrown up when using income drawdown
The government has invested significant time and energy in trying to remove the cliff-edge of retirement. Ministers have for a decade now talked about the desire to move away from a situation where people are in work one day and completely retired the next.
So it is perplexing to find the regulator holds the contrary attitude towards younger users of income drawdown.
Public-sector workers are actively encouraged to take flexible retirement by reducing their number of working days and drawing some of their pension early to make up any shortfall in their income.
Income drawdown offers people with private pensions in their late 50s and early 60s the flexibility to do this, yet the regulator takes such a negative attitude towards anyone who tries to do so.
I have come across many situations where it has made perfect sense for clients to crystallise benefits in their 50s or early 60s. Given the ultra-low annuity rates that will be on offer to them at such relatively young ages, that means going into income drawdown.
Often it will be because clients want to access their tax-free cash for a specific reason. And why not? Crystallising a tax-free lump sum can allow people to pay down debt, clear a mortgage, pay for college fees or scale back the amount of work they actually do.
With the exception of paying a child’s college fees, these are all things that can form the first stage of an individual’s strategy for rebalancing their life to a post-work world. Working day in, day out, earning barely enough to clear the bills every month is not conducive to long-term life planning. Accessing cash tied up in a pension can give people the freedom to give their life a new direction.
Although the Financial Conduct Authority may think otherwise, I rarely find individuals being cavalier with what they spend their tax-free lump sum on. If you have spent your working life building up a fund you aren’t going to blow it on something frivolous unless you can absolutely afford to do so.
There is also logic in using money when you are young enough to enjoy it. While the marketing departments of pension providers are constantly telling us that we are expected to live forever, the sad fact is that not all of us do.
I have a client going through cancer treatment at the moment who wants her lump sum now to clear her mortgage. It makes complete sense for her to do so. Now we have the ability to draw zero income from the drawdown pot, the obstacles to accessing lump funds are much reduced.
As people increasingly find they have to work longer, perhaps up to 70 or even beyond, the practice of accessing tax-free cash before actual retirement will become increasingly prevalent. To say those nearer to age 55 than 75 should not do so makes no sense.
That is not to say that there are not risks out there, because there are lots of them. I find the thought of execution-only drawdown concerning. But there are unfortunately advised clients going into pretty racy arrangements.
I inherited one client recently who, after having drawn his tax-free cash, had been left with a drawdown pot of just £120,000.
Even though he was not a wealthy man he had big chunks of his fund invested in hedge funds and property funds: quite a portfolio for a man of his means. Needless to say, a few years later, after the economic crisis had taken its toll he had just £60,000 left.
Yet even after this experience this client still doesn’t want an annuity, which only goes to show just how ingrained attitudes against annuities can be.
Hopefully, the advent of the Retail Distribution Review will make portfolios like this one rarer, but it underlines the very real risks of drawdown on those who cannot afford to lose the money, without even mentioning the risk of fund depletion resulting from the extra 20% income now allowed to be withdrawn.
But that is a separate issue that should not cloud the debate over whether or not people in their 50s and early 60s should be discouraged from using their tax-free lump sums to make meaningful long-term changes to their personal finances.
Anna Sofat is managing director of Addidi Wealth
Nine in 10 do not have income protection
Set to become part of Single Financial Guidance Body
Also plan to scrap NI on contributions
Eight-week high against US dollar