With annuity rates low and uncertainty plaguing the financial markets, the Financial Services Authority (FSA) has warned that income drawdown could prove potentially risky for investors.
In its Retail Conduct Risk Outlook bulletin, the regulator classified drawdown as being of "potential concern". This is the lowest level of risk classification – behind 'emerging risk' and 'current issue' – but it shows the watchdog's nose is already picking up a scent.
Investors who purchased income drawdown years ago may have bought it because they wanted to maintain some control over their investment choices, were attracted by the superior death benefits and wanted the ability to vary their income over time and take a higher income (120 per cent of the Government Actuary's Department [GAD] rate).
But, since then, a number of things have changed. For a start, the death tax has increased from 35 per cent to 55 per cent for investors aged 75 or older at the time of death. Income withdrawal has been capped at 100 per cent of GAD rate, while markets have become very volatile, leaving some customers with less capital- which, in turn, means the income they can draw down has fallen significantly.
"The FSA is warning all advisers that they must do ongoing checks to ensure an income drawdown arrangement continues to be suitable for their clients. One of the tests advisers have to do is to look at the critical yield – what a drawdown investment would need to deliver to match that of a lifetime annuity," explains Steve Lowe of Just Retirement. So, for example, a drawdown contract for a 70-year-old might need to deliver 8 per cent or 9 per cent gross before adviser charges to match the guaranteed no-risk return of a lifetime annuity.
But – and here's another catch – currently the critical yield tests are benchmarked against a standard lifetime annuity. However many investors might have health and lifestyle issues that would qualify them for an enhanced annuity, which could mean a significant uplift in income. So, using the same example above, the income drawdown investment return might need to deliver 14 per cent or 15 per cent gross returns to match the income of the enhanced annuity.
Clearly the debate surrounding annuity versus drawdown is not a simple one. The decision to enter into drawdown needs to be a fully advised one and it is critical that you prompt your adviser to do the necessary detailed fact find about your health and lifestyle to ensure they do not automatically roll you over into your income drawdown arrangement for another three years or wrongly put you in such an arrangement when an annuity would be a better option.
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