In years gone by, retirement was straight forward. You built up a reasonable fund of money and bought an income for life through an annuity. It was guaranteed and you had a few choices to think of: rising or flat income; guaranteed length of time after death; and spouse’s or children’s benefits were the key items to consider.
Those days of guarantees have gone with the plummet in annuity rates. Annuity rates are currently 29% below 2008 levels alone.
Pensioners moved to protect their income by deferring taking an annuity and allowing their capital to be invested and grow a little longer before potentially buying an annuity at a later date. This plan benefits the pensioner as annuity rates increase with age.
Many pensioners moved their pot of money to a product called income drawdown which allowed them to leave the capital invested, but take a smaller ‘income’ which came from their remaining pot. You can also take 25% of the pot of money as a tax free cash lump sum if you are over 55, and then decide on a level of income (drawdown) that is ‘safe’ to take without putting the remaining pot of money under pressure.
There are countless benefits to this, but it comes with its considerable complications, and that’s where an independent financial adviser comes into their own.
The fund will remain invested, and if the market increases, you will not impact your capital, but if it falls, you will be putting a strain on the existing capital.
There is obviously a percentage you could take from a fund that is considered ‘safer’ to take, that won’t be putting the capital you have under pressure, pressure that might mean you actually run out of money.
If you are considering drawdown, there are a few items to have clear beforehand: Your attitude to risk (ie how much fluctuation are you happy within a fund) is key. A higher risk means you can have more exposure through equities which will give you the higher chance of growth, whereas a lower risk means you cannot. Lower risk means a lower potential return, and less likelihood you will recover from the costs of the investment funds and products you are holding: Ask yourself if you actually want to have any money in the fund as a legacy or if you are happy for it to run out: What is your health and life expectancy – the longer you live, the greater drain on the capital and vice versa: Is your spending in retirement going to decrease or increase – evidence shows it decreases for most people.
And so we look for a magical number or figure we can use, which we can ‘safely’ take as a withdrawal. It’s a number we can stick on the fridge that gives us meaning – or does it?
It’s very much the inherent human desire to sum up complexity with a single sticker or number. Dudley Moore did it for Bo Derek as did Hans Eynsick for IQ. But that probably had more validity.
It used to be 4% withdrawal, and now it’s arguably 2.5% – 3.5% depending on the strain on the underlying fund due to charges and/or tax, but that assumes a straight line without planning. The age old 4% was as flawed as the 2.5% -3.5% is now. Both of these are calculated by clever people on the basis of your fund having exposure to a certain mix of equities and bonds. I’ll not bore you with tearing that theory apart, as it assumes no financial interaction with an adviser to ease through the conditions that affect it. See Bo Derek above.
For example, as markets fall, you should lower your income. If they surge, that’s the time to take out a little more, where capital expenditure is expected. Assuming an equal holding in bonds and equities assumes that holding an equal amount is a good idea, and, that equities or bonds might be okay to hold. That of course, is nonsense.
What happens in the first year is key however, and deferring investing as well as deferring taking income can start your fund off on the very best footing. More on that next week.
About the author
Peter McGahan is Chief Executive of Independent financial adviser Worldwide Financial Planning, which is authorised and regulated by the Financial Conduct Authority.Last modified: June 10, 2021