Annuity rates have fallen off a cliff this year, but income drawdown - the alternative to buying an annuity - could send your pot plummeting to rock bottom with an almighty thud if you make the wrong investments. Poor investment choices after you draw down your pension could deplete your pot to zero faster than you might think - even if returns on your portfolio look deceivingly healthy. But with the right portfolio you could make your pot last much longer. We'll show you how.
Despite the lowest rates for 10 years, annuities are heralded as 'the safe option' when it comes to retirement income. As nothing is guaranteed with drawdown - via which you draw an income directly from your pension which remains invested - it is seen as a more daring option. But some advisers say the biggest threat of all is the effect inflation could have on fixed annuity incomes. If you'd taken out an annuity in the 1980s, it could be worth around half its original value if it isn't inflation-linked, potentially limiting your ability to fund your lifestyle.
With this and your ever-increasing life expectancy in mind, drawdown suddenly seems less dangerous. But this stage of your investment life, which professional investors refer to as 'the de-cumulation phase' can be one of the most precarious of all if you wish to take income from your pot. This is because risk changes. You might be surprised to find out many of the higher returning investments that have helped your hard-earned pension money grow over the years suddenly become unsuitable for you to invest in.
If you're looking to draw an income for a long period of time, volatility is a risk you simply can't afford to have in you portfolio, according to David Tiller, director of strategy and business development at Standard Life. Peaks and troughs are an accepted part of long-term gains in accumulation funds, but when you're de-cumulating, troughs cause losses, which could mean curtains for your retirement income as your pot will simply run out of juice.
Volatility reduction through maximum diversification is the key to making your pot last in drawdown, says Mr Tiller. His strategy for de-cumulation investment is based around what could happen in worst-case scenarios if the markets fall. He claims a lower return fund with minimal volatility will serve you better than a less predictable, higher-performing fund. He holds up to 30 different and completely uncorrelated positions and is confident that his approach carries just a third of the risk associated with an ordinary equity portfolio.
But a blinkered focus on volatility could be dangerous, according to Laith Khalaf, head of pensions investment at Hargreaves Lansdown. He warns: "Don't become a slave to volatility as you could fall into a trap of having to sacrifice returns." He also advised against investing in gilts because yields are so low, and said if you're adopting a very low-risk strategy in drawdown you may as well buy an annuity, because the value would be similar but the income is guaranteed. A better idea, he suggests, would be to focus on low-cost funds that provide income, while taking a conservative approach.
Simon Bonnett, head of wealth management Fiducia Wealth Management, says it is essential to achieve capital growth over the medium to long term, while maintaining a defensive strategy. He helps his clients achieve this by tactically asset allocating between cash, bonds, UK/global equity, commercial property, absolute return funds, hedge funds and private equity.
The next thing you need to figure out is how much income you should take if you want your pot to last. The rules mean if you're in capped drawdown you can only take £5,300 per £100,000 of your pension savings at age 65. Flexible drawdown allows you to take an unlimited amount, but you have to have a minimum retirement income of £20,000 a year to qualify.
Some academics argue that by opting for an overly prudent withdrawal rate, you could be losing out unnecessarily. Because rates are calculated on you living longer than you probably will, they say you may be unduly sacrificing much of your desired lifestyle early in retirement for an eventuality that will probably not occur. But if 'probably' doesn't quite cut it for you (it won't for most people), Tim Stalkartt, managing director of financial planning at Bestinvest, says a safe rate of withdrawal is somewhere between 4 and 4.5 per cent.
Recommended asset make-up of an income drawdown portfolio (%)
Source: Fiducia Wealth Management
IFA-recommended funds for income drawdown portfolio
We asked a selection of independent financial advisers for their recommendations of funds that are suitable for de-cumulation portfolios. The results are in the table below, together with their performance record and costs.
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