When planning for your retirement, the most obvious and straightforward option is to hand your pension pot over to an insurance company in exchange for a lifetime annuity. Provided that it is guaranteed – and not all annuities are – it will provide you with a set income for the rest of your life. The drawback is that once you agree to buy one, the financial cell door closes firmly behind you, leaving you locked in for life and unable to switch to an alternative provider. Anyway, with interest rates seemingly destined to stay at historically low levels, and with insurers helping themselves to a generous “margin” off the top, they are a poor deal.
The alternative approach – and one which should be undertaken only with the help of an investment services specialist with suitable qualifications – is an arrangement called an unsecured pension, or income drawdown.
Provided that your pension pot is large enough, this enables you to take a tax-free lump sum of up to 25 per cent of the fund while leaving the balance invested for you to take more from it in future if you need to.
Drawdown is a flexible alternative not least because, unlike a lifetime annuity, it allows you pass on the underlying fund and its income to your heirs after you die. But as any properly qualified investment professional should tell you, it has its own potential drawbacks.
Not the least of these is the fact that, despite what insurance company salesmen and their seductive brochures like to claim, investment returns never travel in an unbroken straight line that looks as if it is going off the top of the graph.
Long term investments always rise and fall in line with the financial markets and withdrawals will inevitably put stress on your remaining fund, leaving it to compensate for the amounts you have taken out. In strong markets this may be possible; but falling markets can leave you exposed to a financial rainstorm without an umbrella. Unless you have other assets to make up for the shortfall in pension income that such a scenario will inevitably produce your retirement will not be as comfortable as you wished for.
In the worst cases, the underlying fund could become exhausted, leaving with you with a greatly reduced pension and shatter your prospects of a comfortable retirement.
For this reason, wealthy investors who wish to take advantage of the flexibility offered by drawdown should do so only with the expert retirement planning offered by an investment services specialist such as The Whitehall Partnership who will use a proven mathematical model to regularly stress test your portfolio in order to provide realistic forecasts and decide on the best mix of assets needed to achieve your retirement goals.
Other aspects of drawdown and retirement planning will be explored in future blogs from The Whitehall Partnership.