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Avoid paying over the odds for income drawdown

Drawdown is being hailed as a better value for money option than annuities, which are notorious for providing poor value for money for pensioners. But are all drawdown investors getting a good deal?
March 21, 2014

Keen to avoid being 'ripped off' by annuities, shrewd retirees are choosing income drawdown in swarms. But if you believe income drawdown is an easy route to minimising the money pension firms bite out of your pension, you can think again. In a new Investors Chronicle series, we identify some of the poor value for money drawdown advice and products sold to you by pension companies. Are they worth shelling out for? Or might you be better off sorting it all out yourself?

In February, sales of annuities plummeted to an eight-year low, as the woeful deals on offer are deterring pensioners from buying policies that convert retirement pots into guaranteed income. If you choose income drawdown instead, you keep your money invested in the stock market and take from it a level of income of that, within limits, you choose.

Don't pay over the odds for advice

Some retirees choose to take no advice on income drawdown at all and 'DIY' the whole thing. These investors will minimise costs to a few hundred pounds in set-up fees, platform fees and the cost of buying investments.

However, if you're using drawdown to get your main pension income, you may decide to take a more cautious approach to your investing than usual - and you might prefer to take advice from a professional, even if you're an experienced investor. However, most advisers charge around 2 per cent a year for the advice, excluding investment and platform charges.

If you've got a pension pot worth over £100,000 and you're paying for full advice, choosing a provider which caps the fees at a cash limit could be a cost reducing move. Watch out for uncapped charges because they can seriously dent your income. And the bigger the pot, the worse it'll be. A mystery shopping exercise done by a major pension provider, seen by Investors Chronicle, shows how uncapped charges can work out more expensive.

Our mystery shopper approached drawdown adviser Age Partnership with a fund value of £450,000 (after a £150,000 25 per cent tax-free lump sum). It quoted an advice charge of 2.5 per cent of the fund after tax-free cash has been taken, capped at £5,995. In addition to this, there is an ongoing advice charge of 0.5 per cent a year, which for this size of fund worked out as £2,250. But these charges are in addition to Sipp administration charges, platform charges and fund manager charges, which would bump the total costs in year one up to £12,095.

The mystery shopper also received a quote on a £700,000 pot from Hargreaves Lansdown's discretionary management service, which worked out at £14,000 a year (or 2 per cent) in uncapped fees, showing how uncapped fees on large pension pots can work out very expensive.

Tom McPhail, head of pensions research at Hargreaves Lansdown, said: "Costs and risks from large transactions are potentially very high, so we don't set a cap on charges. However, we do discuss all fees with clients and agree individual terms where appropriate."

Drawdown guarantees offer poor value

If you're using drawdown for your primary source of pension income instead of an annuity, you might have a cautious risk appetite towards all - or at least a core chunk of your money. And if you're taking full financial advice, one option your adviser might present you with is a ready-made drawdown investment portfolio with an element of downside protection.

But research done for Investors Chronicle has revealed some of the most popular portfolios bought by thousands of pensioners every year would need to achieve unrealistically high levels of returns to give savers any advantage over buying a standard annuity because they are so expensive.

In the worst case, a portfolio promising around 4 per cent of the pot in annual income would need to return as much as 10.7 per cent a year to provide any advantage over a standard annuity whatsoever. This is very tall order for a fund with a heavy allocation to bonds. On average, savers pay around 1.1 per cent a year for the funds, and between 0.9 and 1.6 per cent for the guaranteed element. On top of this, the adviser charges are typically around 0.5 to 1 per cent a year, meaning the funds must return at least 3 per cent before a level of pension income is even taken into account.

And the guarantees associated with these products aren't always quite what they seem, either. For example, MetLife's Retirement Portfolio offers a Secure Income Option which promises a guaranteed income of 4.25 per cent of your pot every year. But this sounds a lot better than it actually is. The promise is actually 4.25 per cent of your initial investment amount, with no compounding. This means that as time goes by, inflation will eat away at your guaranteed income.

Jamie Fergusson, consultant financial adviser at PQR Financial Planning, said: "The wording in some of these brochures is sneaky, and on the whole, the guarantees offer poor value for money as the high charges mean they have very little potential for upside gains.

"Over the past five years, the performance of these portfolios looks fairly decent, but it has been flattered by the unusually strong performance of fixed income, which makes up a substantial portion of these portfolios. Don't expect this to continue for the next five years," he said.

Mark Stone, pensions adviser at Whitechurch Securities, added: "These are not the panacea product that a lot of people think they are. They can be suitable for a small minority of retirees, but the guarantees sometimes work out very expensive."

A breakdown of popular guaranteed drawdown portfolio charges

Company Product/OptionCost of GuaranteePlan CostsTypical Fund CostsTotal*Hurdle (Income + Charges)Notes
Met LifeGuaranteed Income Option0.95% - 1.5%0.50%0.54%2.24%6.49%Income guraranteed at 4.25% of original investment
PrudentialPrufund In Drawdown0.60%Included in fund cost 1.20%1.70%6.70%Capital Guarantee varies with term/income
MGM AdvantageFlexible Income AnnuityIn cost of product1%0.25% - 2.7%2.81%7.81%Min income guarantee only 50% of annuity rate so not very useful 
LV=Protected Retirement PlanIn cost of productIn cost of productna  Internal Rate of Return 2.5 -3.4% (risk with LV=)

Based on Typical experience for Male age 65 with portfolio of £250,000

Source: PQR Financial Planning