Thousands of DIY investors are in "serious" danger of running out of money in old age because new drawdown rules will allow them to spend their money too quickly, retirement experts are warning.
Income-hungry retirees with poorly-performing drawdown funds will be worst affected, as their pots could be reduced to skin and bone after just a few years if they take the maximum drawdown income.
From 26 March, pensioners that go into capped drawdown, a more flexible alternative to buying an annuity, will be able to take a higher level of income from their investments to fund their retirement.
But the vast majority of the 18,000 retirees who go into drawdown arrangements every year are deluded about the level of income they can take without their funds rapidly shrinking, and often take more income than they can afford without realising it, according to Vince Smith-Hughes, chartered financial planner at Prudential.
Capped drawdown was introduced as part of government reforms to abolish compulsory annuitisation aged 75. And, in 2011, they reduced the amount a person is allowed to take as income from 120 per cent of the equivalent Government Actuary's Department (GAD) rate annuity to 100 per cent.
Currently, the income limit for a 65-year old is 5.8 per cent, but this will rise to 7 per cent because the government is reversing the rules, so people can drawdown 120 per cent of the GAD rate instead of the current 100 per cent limit.
Under current drawdown rules, a 60-year old with a £100,000 fund returning 6 per cent a year after charges could take a maximum income of £4,600 and still have £143,000 at the age of 80. But the new rules mean the same person can take a maximum of £6,120 a year, but by the time they are 80 their fund will have shrunk to just £86,200.
Mr. Smith-Hughes warned: "Aiming too high is an especially dangerous trend for people who are relying purely on drawdown for their retirement income because if they deplete their fund too quickly, in the worst cases they could be left with very little to live on."
John Fox, managing director at Liberty SIPP, is also wary of the new maximum GAD rate and believes picking it could reduce your income by 41 per cent between the ages of 85 and 95.
He warned: "While taking the maximum 120 per cent will clearly improve your lifestyle today, with more people living longer than ever, it could negatively impact their quality of life further into retirement, especially if your fund underperforms in the early years. The extra income people take now has to come from somewhere and that somewhere is the future income of the fund. For some, short-term gain could well result in long-term pain."
How much drawdown income should I take?
The new higher limit isn't a bad idea for everyone. If you're a wealthy investor with significant other income streams in retirement, taking the maximum drawdown could actually be a better option, as it will give you the flexibility to have access to more of your money while you're in early retirement. If you're in this position and about to enter drawdown, you may be advised to wait until after 26 March.
And at the other end of the spectrum, around half of all investors who go into drawdown don't take any income at all. As there is no minimum on the amount you have to drawdown, you can leave your pension fund untouched for as long as you like, while still getting advantage of the tax-free 25 per cent lump sum that's available through drawdown.
But for investors who do want an income without a high risk of depleting their fund, Tom McPhail, head of pensions research at Hargreaves Lansdown, recommends investors take the "natural yield" from their portfolio. This means an income of typically between 3.5 and 4.5 per cent a year - well below the new GAD maximum.
He added: "Any investor looking to take advantage of the maximum income limit should proceed with care as it is possible to run down a retirement fund very quickly in adverse market conditions. It is unrealistic to expect to generate a net return after all investment, administration and advice charges of 7 per cent a year, every year."
A £100,000 fund value assuming 2 per cent gilt yield and current 100 per cent GAD rate
| £100,000 | Drawdown start age 60 | Drawdown start age 65 | Drawdown start age 70 | Drawdown start age 75 |
| 100% GAD | £4,600 | £5,300 | £6,200 | £7,700 |
| Fund value at 65 | £106,000 | - | - | - |
| Fund value at 70 | £115,000 | £102,000 | - | - |
| Fund value at 75 | £127,000 | £106,000 | £97,400 | - |
| Fund value at 80 | £143,000 | £110,000 | £93,900 | £88,700 |
| Source: Prudential. Assumes average investment return of 6 per cent a year after charges | ||||
A £100,000 fund value assuming 2.75 per cent gilt yield and new 120 per cent GAD rate
| £100,000 | Drawdown start age 60 | Drawdown start age 65 | Drawdown start age 70 | Drawdown start age 75 |
| 120% GAD | £6,120 | £6,960 | £8,040 | £9,840 |
| Fund value at 65 | £97,800 | - | - | - |
| Fund value at 70 | £95,000 | £93,000 | - | - |
| Fund value at 75 | £91,300 | £83,600 | £86,700 | - |
| Fund value at 80 | £86,200 | £71,200 | £69,000 | £76,200 |
| Source: Prudential. Assumes average investment return of 6 per cent a year after charges | ||||
