A bold move
Clare Bruce APFS, Chartered Financial Planner
Guardian Wealth Management Ltd (UK)
As recently outlined in the budget, retirees in the UK are to be able to draw and spend more of their pension funds. To those with large funds, this is no doubt very good news and does offer a great deal more flexibility and control over their retirement planning.
One key change is the increase to maximum available income drawdown, from 120% to 150% of GAD. Sound like jargon? Effectively, this now means that a 55 year old can take up to 7.2% of their pension funds as income. In order to ‘maintain’ their pension pot, an investment return closer to the region of 8-9% per annum will be required, when also accounting for costs. To achieve that return consistently, one could assume greater investment risk may become attractive or even necessary, for the retiree. For those entirely financially dependent on their pension drawdown income, this could be perilous as investment returns will have a direct effect on the income available in the future.
Should investment return average only at comparable rates to a cautious investment return over the past 3yrs (of c.4.3%*) the fund of that same 55 year old would not be able to sustain this maximum income by the age of 73, when also accounting for costs**. With life expectancies and healthcare increasing, this could cause major issues for the long term financial wellbeing of our pensioners.
As this area of financial advice is very complex, individuals must be directed toward financial advisers, who, in this current climate could find it safer to advise their clients not to risk their pension funds with these maximum income withdrawals. Then must charge a fee to the client for the privilege of advice unlikely to be heeded and likely in turn gain a signed declaration from the client to agree they have indeed been warned of the risks but want to proceed anyway.
For those in retirement fortunate enough to have other funds and income sources, these changes are undoubtedly liberating. However, those with lesser pension funds and a live-for-now attitude could suffer later on if markets take a tumble, or simply under-perform their required standard for maintaining the selected income level.
So, perhaps the move intends to inject into the economy with further spending from the baby boom generation in the hope this will perhaps, in turn, benefit the markets and provide those investment yields now necessary for the long term financial wellbeing of our pensioners. A courageous risky brilliant speculative audacious thoughtless catastrophic liberating propagandist naive bold move?
*Based on IMA Mixed Investment 0%-35% Shrs returns of 13% over 3 years. Source: Trustnet as of 31 March 2014.
** Here, costs assumed at 1.3% pa, income paid annually in advance
What is income drawdown?
In summary, drawdown is a method of generating retirement income from a pension pot which remains invested in the markets. While the pot remains invested, it will be subject to the fluctuations and volatility of the markets, which in turn can have a direct effect on income available in the future. The great risk with income drawdown is that the pension money runs out before you do – which can be a result of poor investment performance and too much income being taken too soon.
The key benefits to drawdown are the control and flexibility over how income is taken, and the benefits available to the individual’s family upon death.
What is an annuity?
Much has been said about the drawbacks of purchasing an annuity at retirement, but for many clients, an annuity remains the most appropriate form of retirement income as it involves no further investment risk to the individual.
An annuity is a secure, regular income for life, provided to you by a pension provider in exchange for your retirement pot. It converts your pension savings into pension income.
Annuities involve you ‘selling’ your pension pot in exchange for an income contract. They provide long-term financial security by giving a client certainties over the income they will receive for the rest of their life. Annuities don’t always ‘die with you’, as is the myth. Death benefits however are designed at outset, and cannot be changed once the annuity is in place.
If you have any questions about the changes to Pensions in the UK, please contact Clare using the form below.