Back in the early days of pensions, it was difficult for any of us to become motivated to invest into a product you reaped the benefits from 45 years later.
The best time to be investing into a pension, is of course as early as possible given the compounding growth effect. At age 20 however, the general need is a deposit for a house and a few drinks.
For that 20 year old, the return at age 65 is 77.9% on each pound invested. The first year of anyone’s pension contribution will have the longest time to run and grow. The first year’s premium returns 215% as it has the longest to grow.
Having invested to the point when you are ready to take the income, today there are many flexibilities which didn’t exist before and drawdown is one of them.
Drawdown allows you to grab your tax free cash of 25% of the fund, but leave the remaining fund to be invested to allow it to grow further, meaning your fund can grow and increase your future potential income.
You can then decide how much income or “amounts” you want, as and when you need them. There are many “defaults” touted as to the best way to handle drawdown given the risks:
Do I create my new investment spread like this? What income can I take? These are two of the key risks.
To save time - there are no defaults, as the advice very much relates to your views on a number of complex areas.
The general “default” view when previously saving for retirement was that when you are coming close to retirement day, you start to divest away from equities and into more risk averse assets like property and bonds, etc. That was the case when you had to retire at a set date, but that no longer applies. Why, at age 65 with potentially 20 years of investing left might someone reduce equity exposure?
The US has led the UK for a very long time on pension withdrawals, and one study showed that starting with bonds and increasing equity content (which is counter intuitive) worked very well. The real risk is moving into drawdown at the top of a bull market (something you find out after the event), the market tanks, and you are then drawing the same income from a lower capital amount which could erode your capital base.
Having a default answer, doesn’t take into account the obvious of looking at whether or not assets are appropriate at that time ie the peak of a bond market. Similarly, bonds were purchased in a drawdown portfolio to provide negative correlation to equities (a bond is like an umbrella, whereas an equity is an ice cream – so they might normally both do well, but in tough weather, one balances the other out). As we saw last year, bonds were no hiding place and many portfolios have moved toward alternative assets for that diversification. Many “easy choice” default funds simply would not have access to these.
As to what level of “income” or withdrawals? Again there should be no default, but plenty are on offer. The 4% “rule” had been calculated using many historical data points, but it’s fair to say, those market conditions do not apply as freely, given that equity markets have been inflated by central banks and bond prices are so high, which offers low bond yields. Add to this the diminishing natural yields of dividends, and some would agree the withdrawal should be closer to the three per cent mark than 4%.
The skill is in the advice and the actions taken, however. There are countless assessments showing that those who vary their withdrawals to take out larger amounts when markets have surged, plus lowering withdrawals when they tank, create a significantly better and more sustainable income than those who take the default options.
Fundamental in the flaw of the idea of ‘fixed’ or “default” withdrawals is longevity risk. You just don’t know how long you are going to be around, which is why exploring all the options available with your Independent financial adviser is essential.
If you have a financial question please call 01872 222422 or email info@wwfp.net or visit www.wwfp.net
Peter McGahan is the chief executive of independent financial adviser Worldwide Financial Planning . Worldwide Financial Planning is authorised and regulated by the Financial Conduct Authority. The FCA does not regulate credit cards, will writing and some forms of mortgage and inheritance tax planning.
Information given is for general guidance only, and specific advice should be taken before acting on any suggestions made. All information is based on our understanding of current tax practices, which are subject to change. The value of shares and investments can go down as well as up. Your home may be repossessed if you do not keep up repayments on your mortgage.
