If you’re even beginning to think about retirement there’s a good chance you’ll have already come across the concept of drawdown. If your retirement is soon, it’s something you’ll need to know a bit about. And if you’re already in a drawdown plan you may still be working out how to navigate the drawdown landscape successfully.
It’s not something that previous generations of retirees generally had to think about. Most retirees previously used their pension savings to buy an annuity at retirement, giving them a guaranteed pension income. That changed with the 2015 pension reforms, which means that if you have a defined contribution (DC) pension, drawdown may well provide at least part of your retirement income.
So, whether you’re thinking about going into drawdown or you’re there, here are five things you need to know to maximise the benefits.
What is income drawdown?
Income drawdown is an arrangement which allows investors to keep some or all of their DC pension savings invested and take a regular income from them. Drawdown offers the potential to continue growing the pot in retirement – a factor that becomes increasingly attractive as life expectancy rises. But it also comes with greater complexity and risk.
An often under-appreciated benefit of drawdown is that it offers flexibility. For example, you can choose to move some of your pension into a drawdown plan and use the remainder to buy an annuity and/or take it as cash. Here’s more on why annuities should form part of your pension income plans.
Think carefully how much income you need
There are no rules dictating how much you can take out of a drawdown fund, or when. Your level of withdrawal will be shaped by your own needs, savings and circumstances. But there are still general guidelines to follow. For instance, if you also have generous non-pension savings (such as ISAs), you can probably afford to take a bit more risk than someone depending entirely on their drawdown fund for income.
The 4% rule is a popular rule of thumb when it comes to withdrawal levels. This is the sustainable level of income to take from a pension in the first year of retirement to prevent it from running out prematurely, according to research. But other calculations are more modest.
Morningstar has estimated that 2.5% to 3% is a more sustainable level of income withdrawal, when fees and lower expected future returns are accounted for. Much depends on how markets are performing at the time.
Review your investments
The aim in retirement is to invest in a way that ensures our savings will last for as long as we need them – except we don’t know how long that will be. It could be weeks or months, years or decades. So, the strategies you relied on to save for retirement aren’t the ones you’ll need to save during it.
You may need to overhaul your portfolio entirely or simply make a few adjustments – it depends largely on the extent to which your investments are able to give you the income you need in retirement. You’ll need to be extra sure that your portfolio is diversified – spread across a range of different assets to reduce the risk of emptying your pension pot before you die.
You still want to take enough risk so that your money can grow and beat inflation, but less risk than you did before retirement. The composition and balance of your drawdown portfolio will depend on factors including your risk profile, objectives and other savings, so advice is well worth investing in. Read our tips on how to invest successfully in retirement.
Avoid the transfer trap
The drawdown market is competitive and if you’re in an older pension scheme there might be a good case to transfer your pension to a newer, lower cost drawdown scheme. If your pension doesn’t offer drawdown you may need to move your pot to a different pension, such as a Self-Invested Personal Pension (Sipp) to get access. But there are pitfalls to be aware of here.
One of the biggest is the risk of giving up guarantees that are more valuable than you realise. Some older pensions have restrictions that prevent transfers, or exit charges that could more than wipe out the benefits from transferring out. And if you’re in a defined benefit (DB, or final salary) pension, think especially carefully about transferring out. It will likely mean giving up valuable ‘safeguarded’ benefits such as guaranteed minimum income levels and guaranteed annuity rates that are far more generous than you’ll get elsewhere.
Many pension providers will only accept certain pension transfers if financial advice has been taken – and that advice is well worth seeking.
Choose your platform wisely
Many people remain with their existing pension provider when going into drawdown, but with a growing number of platforms offering Sipps it’s often worth shopping around. The most suitable platform for you will depend on factors including charges, the size of your pension, how much flexibility you want, the investment choice you’d like and the extent to which you’d like access to tools, research and support.
Sipp charges can vary widely, with several newer zero-commission brokers offering lower-cost options. Lower charges often – but don’t always – come with less investment choice, so it’s about finding the right balance for you. Look out for extra charges too. For instance, some platforms charge for setting up drawdown, while some allow a limited number of free withdrawals but charge for additional ones.
Our article on the best platforms for Sipps will help, while you can run your own free search using our platform comparison tool.
