Thousands of retirees enter 'drawdown captivity' as market falls hit pensions
In the first six months following the introduction of pension freedoms in April 2015, over 43,000 drawdown plans have been sold, according to a report from retirement specialist Retirement Advantage.
But the company estimates that the current market volatility could have wiped 8% off the value of a typical drawdown fund since April 2015.
Income drawdown plans aim to give people more flexibility with their pensions. Each time money is moved into drawdown, up to 25% can be taken as a tax-free lump sum. The remainder stays invested and taxable income can be drawn directly from the pension.
However, drawdown income is not secure: it could run out, if you take out too much, if you live longer than expected or if your investments do not perform as you had hoped.
Read our article 'Income drawdown: a back to basics guide'.
Wait for markets to recover
In the current economic climate, many people could be much better off waiting for markets and pension values to recover before taking an income from their fund, says Retirement Advantage.
It points out that a retiree who took out an income drawdown plan at the start of April 2015, for example, would have done so when the FTSE 100 stood at 6961 (7 April 2015).
The FTSE 100 closed on 28 January 2016 at 5931 points, down 15%. But most drawdown customers will be in a mixed portfolio of equities, bonds and cash, which could have fared slightly better with a drop of 8% before charges.
The report highlights the danger of market falls for someone who has just retired and has to continue drawing an income from their shrinking portfolio.
For example, a £100,000 drawdown plan invested in a mixed portfolio of assets (after withdrawing an income of £5,571 which matched the annuity rate available at the time), would now be worth £86,522, or 13.5% less than nine months ago.
'This won't be a great start to your retirement,' says Andrew Tully, pensions technical director at Retirement Advantage. 'Losing around a tenth of your pot in 10 months will leave many people feeling queasy about the future.
'It is easy to say don't panic, but you might well be spooked if you are relying on drawdown to generate an income, as you will probably need to sell units in a falling market.'
This, he says, may push people who do not want to crystallise losses but are short of alternatives for paying the bills into a period of 'drawdown captivity'.
The old days of using either an annuity or a drawdown plan are over, says Tully. 'If you want to sleep easy at night, then a blend of both products may be best.
'You can secure a guaranteed income to pay the bills, and this allows you to adopt a longer-term strategy for the growth element, giving flexibility to ride out stock market storms.'
Read our article 'Income drawdown, annuity - or both?'
The term is interchangeable with stock exchange, and is a market that deals in securities where market forces determine the price of securities traded. Stockmarket can refer to a specific exchange in a specific country (such as the London Stock Exchange) or the combined global stockmarkets as a single entity. The first stockmarket was established in Amsterdam in 1602 and the first British stock exchange was founded in 1698.
Tax-free lump sum
An inelegant phrase that is nonetheless accurate in what it describes: a one-off payment to a beneficiary that is free of any form of taxation. Usually received when using a pension fund to purchase an annuity, as 25% of the overall fund can be taken as a tax-free lump sum.
An alternative to an annuity, income drawdown (also known as an unsecured pension) allows you to take income from your pension fund while the fund remains invested and so continues to benefit from any fund growth. The drawdown of income has to be calculated carefully as taking too much income could exhaust the pension fund so experts say the annual drawdown must not exceed what the assets would normally yield in an average year. The invested pension fund could also be hit by market turbulence and the value of the assets could fall.
A market-weighted index of the 100 biggest companies by market capitalisation listed on the London Stock Exchange. It is often referred to as “The Footsie”. The index began on 3 January 1984 with a base level of 1000; the highest value reached to date is 6950.6, on 30 December 1999. The index is “weighted” by how the movements of each of the 100 constituents affect the index, so larger companies make more of a difference to the index than smaller ones. To ensure it is a true and accurate representation of the most highly capitalised companies in the UK, just like football’s Premier League, every three months the FTSE 100 “relegates” the bottom three companies in the 100 whose market capitalisation has fallen and “promotes” to the index the three companies whose market capitalisation has grown sufficiently to warrant inclusion. Around 80% of the companies listed on the London Stock Exchange are included in the FTSE 100.
An interchangeable term for shares (UK) or stocks (US). Holders of equity shares in a company are entitled to the earnings and assets of a company after all the prior charges and demands on the company’s capital (chiefly its debts and liabilities) have been settled. To have equity in any asset is to own a piece of it, so holders of shares in a company effectively own a piece proportionate to the number of shares they hold. (See also Shares).
In exchange for any lump sum – usually your pension fund – an annuity is “bought” from an insurance company and provides an income for life. When you die, the income stops. Annuity rates fluctuate daily and depend on your sex (although from 21 December 2012 insurers will no longer be able to use gender as a factor when calculating annuities), age, health and a number of other factors, so you have to pick the right one and, once bought, its terms cannot be altered, so seek financial advice.