Ask The Experts - Risks of Income Drawdown

Question: Surely far too much risk at the moment for my captious investors to ply their funds into Income Drawdown…. Historically, in my opinion, over the long term equity investment has managed to produce the required levels of returns, however, the increasingly poor stock market conditions and low returns in other sectors have indicated that it could be difficult to achieve a good level of growth in the future. So, what does the future say about Income Drawdown? Will 6th April be a major changing point?

Answers:

Fiona Tait - Scottish Life

You make a good point about long term returns. It is often thought, with good reason, that income drawdown is a short term contract and should therefore carry less investment risk than a pre-retirement plan.

This is of course true in many cases, as the client requires ongoing access to their benefits, specifically income. However as I think I have mentioned in a previous reply, Scottish life are finding that a very significant proportion of our income drawdown clients are not in fact taking any income after accessing PCLS. Younger clients who have taken PCLS but are not planning to stop work or take retirement income for another 10 years or more do not in fact have a risk profile that is much different than any pre-retirement personal pension plan holder. So it's all down to the individual's attitude to risk....

Where the changes on 6th April may have an effect is in effectively reducing the term from initial accessing of benefits to the point at which people retire and require income.

Vince Smith-Hughes - The Prudential

When considering income drawdown it is always important to consider the following in the right order.
• Attitude to risk
• Income required
• Yield required to maintain income
• Portfolio required which is likely to meet yield requirements

Quite often the investor may feel uncomfortable with the level of risk which is required to maintain the level of income. If this is the case there are several options.
• Consider an alternative product for all or part of the fund
• Consider buying a guarantee, such as the ability to secure a minimum fund value at the first GAD review
• Consider reducing the income if possible
• Acknowledge and document that the fund is likely to deplete

There are many other reasons other than just securing income why someone may wish to consider income drawdown, including flexibility of income and death benefits, and for this reason drawdown may still be an option for the cautious. With-profit funds should also be considered as they have advantages in both smoothing of stockmarket fluctuation and also do not suffer from poor timing of withdrawals in the same way as most funds.

In relation to 6 April, the primary concern is that anyone who is over 50 and not yet 55 should seek advice if there is any possibility they want to take any cash or income from their pension in the short term.

Stewart Dick - Hornbuckle Mitchell

The recent turbulent market conditions have certainly proved challenging for some income drawdown cases, proving the point that it's not necessarily the best route for every client. However, fluctuating markets also demonstrate some of the major advantages of income drawdown, particularly when operated through a SIPP plan.

The drawdown rules allow the level of income being taken to be altered (within certain parameters) to suit the client's needs - for example if the erosion of capital is a concern then income can be reduced or even stopped (pre 75). While stock markets and other sectors may look less than attractive, a flexible contract allows clients to turn to other investment classes that may be more appealing - for example we've seen an number of SIPPs turn to investment in gold bullion or unquoted shares. In addition, the ability to remain invested while in income drawdown means that those clients that have suffered losses to portfolios should hopefully be able to benefit from future gains as markets recover. Another relevant factor is the different death benefits available under income drawdown compared to an annuity.

However, we appreciate that some of these investment strategies may be too adventurous for the more cautious investors - for them the certainty of income provided by an annuity is far more attractive. Of course the big issue with annuities just now is the current low rates. Income drawdown can therefore help as a simple timing mechanism to defer annuity purchase until rates have improved.

With the above in mind, we are confident that the income drawdown market will continue to grow. A Defaqto survey in 2007 stated that 33.5% of IFAs advised on income drawdown with that figure set to increase, and 82.6% rated income drawdown as important or very important for future advice. Our experience has borne out these predictions, and while the run-up to the change in rules in April may see a rush of drawdown activity, we don't see the changes altering the popularity of, or need for, income drawdown going forward."

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