New regulations on income-drawdown plans should make it easier for savers to make sensible decisions on retirement. The rules, which come into effect on 1 February, are primarily aimed at savers who don’t take financial advice before opting for a drawdown scheme, even though the schemes require some challenging investment decisions.
Income drawdown plans have become the automatic choice for many savers as they reach retirement and need to begin taking an income from their pension fund. But unlike annuities, which were once the most common way to convert savings into income, they don’t pay a guaranteed income for life. Savers must manage their pension funds to keep generating the income they require while ensuring there is enough cash to last them through their retirement.
Regulators have long been concerned that more than a third of savers taking out drawdown plans do so without consulting a financial adviser. Their solution is to order drawdown providers to offer ready-made investment deals to savers on retirement, with four separate “investment pathways” aimed at people in the most common situations.
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How long to retirement?
Different investment solutions will be appropriate for each of the four groups: those who have no plans to touch their money for at least five years; those who intend to start taking an income within five years; those who expect to take all of their money within five years; and those who plan to use their drawdown fund to buy an annuity within five years.
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Regulators have asked providers to design default investment strategies for each group, so that more savers end up with drawdown investments that are well-suited to their circumstances. In practice, product providers will have freedom to select the investment products they believe are right for each group, but they are likely to take a similar approach.
For example, savers with no plans to draw down income for five years or more will largely be offered balanced investment funds, providing exposure to the stockmarket that offers the potential for further capital growth, as well as lower-risk assets to provide some caution. Savers planning to begin drawing down income within five years might also be offered a balanced investment product, but with a more cautious strategy that is less exposed to the stockmarket.
By contrast, savers expecting to withdraw all their cash within five years are likely to need an investment fund with a great deal of downside protection. That might mean moving the fund largely into cash. Those expecting to buy an annuity might be offered a fund invested in gilts, since the performance of UK government bonds is closely linked to annuity rates.
Look beyond these choices
However, while these default strategies should mean fewer savers end up invested in inappropriate assets, they don’t provide any help with other crucial drawdown questions. For example, savers will still need to think carefully about how much money they can afford to take out of their plans on a regular basis, and how much of their 25% tax-free lump sum they should take upfront. Tax planning will be another important consideration for many people.
The upshot, then, is that the vast majority of drawdown savers will be better off taking independent financial advice on their retirement options, rather than depending on the new pathways.
Bear in mind too that you do not have to accept the default investment solutions proposed by your drawdown provider, even if you fit into one of the four standard groups. Many providers will also offer more complex strategies, or you are free to make your own decisions.
