It seems to be common practice for private banks and wealth managers to say one thing and do the other. Reliance on private pensions is growing as a result of the UK’s ageing population. Income drawdown is a popular method of taking retirement benefits for those people with larger pension pots. But unreliable information can lead to irreparable financial damage.
The average size of personal pension funds at retirement in the UK is about £30,000, whereas a pot of more than £150,000 is the realistic minimum required for drawdown, though in the right circumstances it may be appropriate for those with a smaller pot. However, the majority of people will probably still purchase an annuity, because it is the best way of securing a guaranteed income in retirement.
Income drawdown is an alternative to buying an annuity. Providers of these schemes must supply the investor with certain information, including retirement illustrations. These illustrations show projected values of the retirement pot after pension withdrawals are taken. Typically, providers will show estimated growth rates of 5%, 7% and 9% but these estimates may be different from actual returns.
Worcestershire based wealth managers The Whitehall Partnership is calling for greater clarity on income drawdown projections supplied by pension providers. John Taylor a senior advisor at the firm said it would be dangerous for investors to rely on standard projections alone.
Drawdown is only suitable for those with above-average pension pots, because there is more risk and complexity. Investing in drawdown is more risky than buying an annuity, because drawdown pension pots are invested in the stock market. This means that if investment returns are lower than expected, the value of the pension fund will be eroded more quickly.
Despite these risks many independent financial advisers and pension providers fail to explain the dangers of income drawdown. Mr Taylor says “The real problem lies in the timing of withdrawals relative to the value of the pension fund”. Typically, providers of these pensions are required by law to produce an illustration which projects the value of the pension pot going forward. But in practice a very different picture could emerge, especially if income is withdrawn during periods when the stock market has fallen.
Mr Taylor goes on to say, “Because standard illustrations ignore movements in the stock market, alternative methods are required to stress-test the pension fund”. Mr Taylor says computerised investment modelling has been around for many years but many advisers find it too complicated. Broadly speaking, investment modelling aims to select investments which have the highest probability of achieving a stable long-term income from a pension pot.
Controlling risk is the most problematic issue behind most income drawdown plans. It is therefore essential to apply sophisticated planning methods beyond standard projections. Another useful tip for investors is to keep an eye on charges, because some are not fully disclosed in projections. Mr Taylor describes that many wealth managers offering income drawdown advice simply charge too much for their services. He said, “Many wealth managers are racking-up combined charges of over 3 per cent annually”. He advises investors to understand the full extent of charges and to cap total annual charges at 2 per cent.
Money saved in charges can remain invested and growth is allowed to compound every year. Mr Taylor said the effect of compound growth on averted charges means savvy investors can take less risk with their money or end up with a larger fund. This also means that income drawdown plans are given the opportunity to sustain withdrawals, especially during market falls.