Following reforms announced earlier this year new figures have shown that pensioners are piling into Income Drawdown contracts.
At the same time the average amount being transferred to Income Drawdown has shrunk, leading to fears that pensioners could be making unsuitable choices about their retirement income.
The research produced by the Prudential, based on information from the Association of British Insurers, shows:
- Sales of Income Drawdown plans have increased by 73% over the past year
- Despite becoming more popular, the average amount transferred in to Income Drawdown plans has reduced by 8.4%
- The average pot size for an Income Drawdown plan is now £70,500
Traditionally it has been thought that the minimum amount needed to make Income Drawdown work was £100,000. Although this is something of an arbitrary figure, and each case is different, the new figures do make us concerned that some people are choosing Income Drawdown when it isn’t appropriate.
So, if you plan to take advantage of the new ‘Pensions Freedom’ rules and use Income Drawdown, do you know the risks?
Here five you need to be aware of:
Risk #1: Running out of money
Once you reach 55 the new rules allow you to take out as much as you like from your pension. You need to remember though, that unless you have other sources of income to cover your outgoings, your pot will need to last until you die. Perhaps even longer if you have a spouse who will need the income.
Calculating how much you can take out each year, without running out of money, will be one of the toughest challenges pensioners will face under the new rules. After all, no one knows exactly when they will die, or how their outgoings will change in the future.
Risk #2: Poor investment choices
Taking too much money from your pot is dangerous, but so is making poor investment choices.
Of course you need to be comfortable with the risk you are taking, but, take too little risk, for example by investing your entire fund in Cash, could mean inflation erodes the value of your pot. Conversely, taking too much risk and you could see the actual value of your pot drop.
Poor investment returns and high withdrawals are a dangerous combination, potentially impacting on your ability to pay your bills in the future.
Risk #3: Paying too much tax
You will still be able to have 25% of your pension fund out as a tax-free lump sum. But anything more than that will be added to your other income and taxed, at a rate of 20%, 40% or even 45%.
Taking too much money out of your pension, could result in paying more tax than would be necessary after some careful planning.
Risk #4: An Annuity might be better
Annuities were never really loved and during the course of 2014 some of the financial media have portrayed them as toxic products. But, for those people who want a guaranteed income for life, and perhaps that of their spouse, coupled with a relatively simple solution, an Annuity could be the right option.
An Annuity provides a known and guaranteed income for life, something which Income Drawdown cannot do.
For some people an Annuity may be a better option than Income Drawdown. Of course, independent advice is important here, and the right answer might actually be a combination of products rather than ‘putting all of your eggs in one basket’.
Risks #5: Costs may rise
Although this is becoming less of a problem, if you don’t select your Income Drawdown provider carefully, you could see your fees rise.
Many companies who offer Income Drawdown, including SIPP (Self-Invested Personal Pension) providers, charge an additional fee. Some also charge for each payment, which could mount up if you decide to make a large number of withdrawals.
Simply put, the more you pay in fees and charges, the less there will be for you; choosing your Income Drawdown or SIPP provider carefully is therefore very important.
There are of course advantages to Income Drawdown, which include:
- It allows you to alter the amount of income you are taking to suit your needs, which of course will change over time
- Your pension pot remains invested, which means it could grow in value, of course, the opposite may also happen
- From April 2015 Income Drawdown will allow you to take lump sums from your pension pot
- A wider range of options, including ongoing income, as well as lump sums, are available on your death
- You can choose to buy an Annuity at a later date. However, if you buy an Annuity you cannot then change your mind and move into an Income Drawdown plan
We’re here to help
If you are considering using Income Drawdown instead of an Annuity when you retire, it’s important you know the implications of your decision and that the plan is set up in an appropriate way.
Our Independent Financial Advisers are experts in advising people close to retirement. We will spend time understanding your situation and then produce a bespoke recommendation to meet your needs.
For a free initial and no obligation chat, contact us today on 0115 933 8433 or complete our online enquiry form.