What are the risks for drawdown investors?

Since the pension freedoms were introduced back in 2015, many retirement investors have opted for income drawdown as part of their retirement income strategy. This can make sense for many, but there are risks involved.

Drawdown is a way of using your pension pot to give you a retirement income, while the pension pot itself remains invested. You can opt to take up to 25% of your pot as a tax-free lump sum at the outset, and then draw a taxable income from the rest of the pot as and when you want to.

This all sounds good but you need to be aware of the risks. These include your choice of investments for the pension pot, the level of income you decide to take and of course how long you need the pension to last.

The latter is a significant point, with life expectancy increasing for both men and women and with record numbers now living to the age of 100. So you may need to take a view on how long you are likely to live, if drawdown is central to your retirement income.

Your choice of investments also carries risk. Whilst keeping your pension pot in drawdown gives you the opportunity grow the value of your pot and maximise your income, you need to remember that investments can go down as well as up.

Volatility is a characteristic that all investors should expect to experience at various points and the current market uncertainties are a case in point. Drawdown investors need to take extra care with their portfolio mix to minimise the impact it may have on their capital and to protect their retirement income.

Investors should therefore review their drawdown portfolio on a regular basis, and make changes where necessary, both in line with market conditions and with their own changing goals and circumstances. A well-diversified portfolio, with a mix of equities and bonds, and for example a mix of defensive funds with more aggressive funds that target growth, might be appropriate for some.

Whatever you decide, you should be mindful of how long you need the pension to last, and that the performance of your investments could affect how much income you are able to take.

Some people opt to take a fixed income from their drawdown pot. However on occasion, this could mean having to sell investments to fund your withdrawals. Where possible, you should consider only taking the natural income generated by your investments, thereby leaving your capital untouched. This is commonly known as taking the natural yield. Adopting this approach obviously means your monthly income will fluctuate. If this is a problem, having a cash buffer can help make it easier to cope with the flexible withdrawals.

Because drawdown income is not guaranteed, some investors who are not fully comfortable with the risks opt to use some of their pension pot to buy an annuity as well. This is less flexible but provides the security of a guaranteed income for life, no matter what the markets are doing. A mix of guaranteed income combined with the flexibility of drawdown and the state pension works well for many.

Of course, it is not essential to keep all of your money invested. However, holding cash has its own risks as it can lose value over time when interest rates are low and inflation is high. So in most cases, holding large amounts of cash is not the best long-term investment choice.

The final risk for some is not taking financial advice. If your affairs are relatively straightforward and you are a confident investor, you may not need advice. But if your financial situation is complicated and managing your affairs looks as if it may become difficult going forward, then getting objective professional financial advice could be the answer.

If that’s the case, then contact Kellands and we’ll be delighted to help.

 

Pension investment funds and the income from them may fluctuate and can fall as well as rise.  Eventual retirement income will depend on the size and value of your pension pot, future interest rates and tax legislation. Tax treatment is dependent upon individual circumstances and may be subject to change in future.

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