Pension freedoms are aimed at giving retirement savers more options about how to spend their money, but volatile markets have ravaged their investments and made many poorer.
Thousands of pension savers have opted for income drawdown – where they dip into their pension each year to top up their income.
Typically, this is 5% of the value of the fund. This tactic is fine while markets are on the up, but a disaster when they fall.
Take a pension saver with a pot of £100,000 drawing 5% of the fund a year as income.
Providing the savings that stay invested grow at more than 5%, the withdrawn money is replaced in time for the next withdrawal.
Planning for market slumps
If the fund slumps by 10%, then another 5% cash is withdrawn, the saver needs an impossible return of more than 20% in a year to get back on track as savings and returns are diminishing at the same time, says investment firm Retirement Advantage.
Between April 2015, when pension freedoms were introduced, and January 2016, an investor with a £100,000 pension who has taken around £5,500 in income needs an investment return of 13.5% to replenish their fund back to £100,000 ready for another drawdown.
Market volatility has exposed one of the flaws of flexible drawdown.
Retirement savers need a Plan B for when the good times turn bad.
Losing a large part of a lump sum pension pot in less than a year will make many retirement savers uneasy about how long their funds will last and just how much they have to spend.
A bad trading day makes a difference
Making withdrawals in a falling market are almost impossible to recover in later years without the markets returning some stellar double-digit gains that are against the trend.
Some advisers are touting annuities as an option. Although the yields are poor, they do offer a guaranteed income for life regardless of how markets perform because the returns are locked in on purchase.
Vince Smith-Hughes, a retirement expert at financial firm Prudential, says the firm has run a what-if study that shows a fund hit by an early year market slump will always do worse than one that does well then suffers a slump.
“Even a bad day at the markets can make a difference,” he said. “It’s a good idea to search out funds that smooth gains and losses while offering strong returns, but they are few and far between.”
I think 5% is way over the top for an income withdrawal. There is only one way the fund will go- South.
And, given bond fees of 1%, fund fees of 1.75% and adviser fees of 1% a 5%pa return is only going to give 1.25% growth.