Crash may force retirees to reduce annual drawdown income by 9%
In a recent post I covered the potentially catastrophic impact on recent retirees of a market crash so early on in the drawdown of their pension. The concept of ‘sequencing risk’, as it is known, works like this – during a weak market as we have seen recently, if you sell assets to maintain a set level of income, you have to sell them when they’re worth less. In other words, when the price of the shares or funds you hold is lower, more of them need to be sold to provide you with the same amount of cash. Selling more units means weaker returns over time and reduced income from dividends or bond coupon payments, so more units have to be sold in the future to maintain the same level of income.
In the post on ‘5 Ways to Protect your Retirement and Pension when the Markets crash‘ I included a hypothetical chart showing the impact of Sequencing Risk – but now Aegon have modelled the impact of the real market crash on a retiree who invested their £100,000 pension pot in drawdown in early April, with a view to taking £5,500 a year of income from the pot.
Based on performance of the FTSE-100 since the new pensions rules came into force on 6 April, Aegon calculated that a retiree with £100,000 invested who started drawdown on that date could well have seen the value of their pot decline over 10% in the last five months. The result would be that their savings would run out around five years earlier than expected, assuming no pick-up in equity values beyond typical growth rates.
Given that the market downturn has occurred early in retirement when the pension pot is at its biggest, such a fall has particularly unwelcome consequences – as the chart shows, the retiree would need to reduce their subsequent income by £500 a year, or 9%, to compensate for the impact of this market fall early in retirement.
As more and more retirees opt for the flexibility of drawdown over the certainty of an annuity, the recent market crash will highlight the importance of addressing this issue and regularly reviewing retirement planning assumptions – including measures to mitigate against the negative impact of any future such market falls. We covered some of the ways to mitigate the risk in the recent post, but one we have yet to cover is the relatively recent emergence of guaranteed drawdown policies, in which a minimum level of retirement income is guaranteed. Clearly there is a cost attached to such a guarantee, but these policies do provide something of a halfway house between the certainty of an annuity and the risks involved in drawdown. As such they certainly merit investigation and consideration by those looking at a drawdown option.
Not surprisingly, given their highlighting of the issue, Aegon have their own guaranteed drawdown product which you can review on their site. We will be looking at some of these products in future posts and trying to assess whether they offer a credible and worthwile alternative to the other options available.
Over to You
If you have recently taken out a guaranteed drawdown policy we would love to hear from you – tell us how easy it was to understand, the process you went through and any advice you took beforehand, and from whom. A small prize awaits the most interesting comment.
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