The drawbacks of pension drawdown
Income drawdown – tapping your pension savings for income – can be risky, says David Prosser. Here's what to watch out for.
Income drawdown, a means of securing an income from your pension without buying an annuity, has been an option since the pension-freedom reforms were introduced in 2015. But it is not suitable for everyone. Insurer Prudential reveals that 56% of savers with drawdown plans have felt compelled to reduce the income they take from their pension plans during lockdown.
The research highlights the crucial difference between a drawdown scheme, which gives savers the flexibility of being able to take money directly from their pension funds as and when they see fit, and an annuity purchase, the traditional way to convert a pension fund into retirement income.
While annuities pay a guaranteed level of income for life, savers with drawdown schemes must manage their funds carefully to ensure the money lasts throughout their retirement. When markets fall, they may have to cut back on income to avoid depleting the fund too rapidly. In other words, income-drawdown plans come with more risk.
They have advantages, enabling you to take lump sums or income from your savings while continuing to invest the money in pursuit of more growth. Savings in drawdown are also easier to pass on to heirs if left unspent. But there are no guarantees about how much income you’ll be able to take safely from your savings – and no certainty that you’ll have enough savings to last your entire retirement.
Finding the right plan
Choosing the right drawdown plan can help you mitigate these problems. Look for a provider with a wide range of investment options, so that you can move into less risky asset classes if necessary, and seek out low charges that won’t eat into your savings too quickly.
A financial adviser can help you decide whether drawdown is right for you in the first place, given your circumstances and your attitude to risk. An adviser will also check the terms of your pension plans; if you began saving some years ago, your existing plan may come with valuable guarantees that will be lost if you transfer into an income-drawdown product. And if you do go for drawdown, an adviser can also help you balance your need for retirement income with preservation of savings and future growth.
The Association of British Insurers (ABI) warns that many savers aren’t getting this balance right in drawdown. It says 40% of pension savers are withdrawing an average of 8% of their pension fund each year, which is unlikely to be sustainable. The ABI says annual withdrawals of up to 3.5% will give you a 95% chance of your savings lasting for your entire retirement.