The pension income-drawdown time bomb

Old people looking at a car brochure © Juice Images / Alamy Stock Photo

Then twice before tapping your pension to buy that car

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published 13 November 2019

Are pension savers heading for disaster by taking too much cash out of income drawdown plans early in retirement? Research from personal finance analyst Moneyfacts suggests that 70% of savers opting for a regular income from an income drawdown plan are taking 4% or more of their fund out each year. That includes 30% who are taking an income of 8% or more. Moneyfacts also reckons that 13% of savers have already burned through their entire pension fund.

A crisis is brewing

We may be heading for a crisis with income drawdown plans, which have soared in popularity since the pension freedom reforms of 2015. While the vast majority of savers used to convert pension fund savings into income via an annuity guaranteed for life, income drawdown plans allow you to withdraw cash directly from your pension fund. Crucially, there are no limits on withdrawals and nothing to stop you withdrawing your entire pension fund early in retirement, or even in one go.

Moneyfacts' data echoes recent warnings from the Financial Conduct Authority (FCA), the financial watchdog, which has repeatedly suggested that savers may be withdrawing too much from their pension funds. The FCA estimates that 40% of income drawdown plan holders are withdrawing at least 8% of their pension fund each year.

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There is no clear limit on how much you can take out of your pension each year if it is to last for your whole retirement. That will depend on how long you live, but the way in which you invest your remaining pension fund will also be important, since this provides opportunities to replenish your savings. However, financial experts suggest that a withdrawal rate of 3% to 4% a year is at the top end of a safe drawdown programme, particularly for savers who have invested their pension fund in low-risk assets likely to generate lower levels of return. In that case, many savers will run out of pension fund well before their deaths.

So far, however, regulators have been reluctant to intervene. One major problem is that their data is incomplete: it measures people's withdrawal rates from each pension fund they hold rather than from their entire pension savings. In many cases, regulators suspect, savers withdrawing significant levels of income from one fund have other pension plans to fall back on.

Still, the data shows that people taking out income drawdown plans without first consulting an independent financial adviser are more likely to be withdrawing larger amounts. That suggests some may not understand the risks they are taking. Many in the pension industry now believe that the spread of income drawdown plans may prove to be a time bomb.

David Prosser is a regular MoneyWeek columnist, writing on small business and entrepreneurship, as well as pensions and other forms of tax-efficient savings and investments. David has been a financial journalist for almost 30 years, specialising initially in personal finance, and then in broader business coverage. He has worked for national newspaper groups including The Financial Times, The Guardian and Observer, Express Newspapers and, most recently, The Independent, where he served for more than three years as business editor.