To make an informed choice between personally researching and implementing a pension drawdown arrangement or taking pension drawdown advice (with an associated cost) there are some basic questions to answer, including:
- How capable am I of understanding the key issues and making decisions?
- Do I have the time/inclination to take on the task myself?
- What is my attitude towards risk and loss?
- What is the maximum potential for capital erosion if a wrong decision is made?
- How likely is it I will make that wrong decision?
- How does the potential for capital erosion compare with the cost of financial advice?
- If I take advice how can I be assured the advice will be of high quality and substantially better than the information I may collect from published sources?
Of course, the answer to many of these questions will vary greatly between one individual and the next. Some may be time limited or risk and loss adverse leading them to seek out an appropriate financial adviser. Others may be more financially experienced and base their decision purely on the potential for capital erosion versus the cost of advice.
The Potential for Capital Erosion
The potential for capital erosion can be difficult to assess. As an example, if an individual withdraws an income of £10,000 in a single year from a £250,000 drawdown pension fund then to maintain the capital sum the invested drawdown fund needs to grow roughly five percent (above inflation) over that year.
If in the above example due to poor choice of drawdown fund or investment profile the investment only grows by three percent then the loss over the year on the capital sum will be approximately £3,000. The impact of a invested drawdown fund performing poorly over several years can, therefore, be significant.
The question is then could professional advice deliver better outcomes than basing decisions on experience (if any) and free published information? Put another way would taking advice significantly reduce the potential capital erosion and would the cost of that advice compare favourably with the potential loss?
It is true to say the quality of advice varies across the industry and some advisers may have much more experience of drawdown arrangements than others. It is therefore important to choose an adviser wisely.
When deciding if professional pension drawdown advice is required (or not) there are three important points to consider
- Withdrawal profile
- The need for a plan
- The impact of fees and charges
Capital Withdrawal Profile
It is critical to understand the implications of taking income from a drawdown fund when markets are down. With the capital value of the fund falling taking withdrawals further depletes the fund making it much harder to recover to the original capital value when the markets turn.
There are two possible solutions to this problem. The first is to hold sufficient cash to avoid taking income from the drawdown fund while markets are down. The second is to maintain a well balanced portfolio. History shows markets rise and fall the challenge is to maintain the right investment portfolio and that generally requires a level of expertise.
The number one objective of any drawdown fund is to avoid running out of funds during retirement. The above discussion on withdrawal profile perhaps illustrates some of the challenges involved. It is, therefore, crucial to have a plan in place, something to compare the actual situation with what was expected at any point in time.
An experienced adviser will help you put a plan in place. If not following the advice route it is important to ensure the planning process is not neglected. Based on a simple gap analysis a plan ensures adjustments may be made to the withdrawals profile and perhaps the investment portfolio to ensure appropriate outcomes are achieved moving forward.
Fees and Charges
Return on investment is not the only consideration as fees and charges can have a major impact over time on the value of a drawdown pension fund, particularly for smaller funds. There has been much criticism of fund charges and a perceived lack of transparency.
It is important therefore to choose the right drawdown arrangement at the outset. Choosing one that both delivers the best investment returns and low fees and charges. Of course, if a mistake is made it is possible to move between funds but there is a potential for loss in the time it takes to spot the error and there could be costs associated with making a move.
The above is a much simplified overview of the key issues with the financial examples based on a short term view but it does perhaps illustrate the decision making process. If a decision is made to follow the pension drawdown advice route it is important to invest time and effort in building a long term relationship with an adviser. With increasing age and/or deteriorating health a trusted adviser may be required to take on ongoing management of a invested drawdown fund at some point in the future.
It may be at some point in the future it may be best to use a drawdown pension fund (in part or in full) to purchase an annuity to secure a known income until death. Should this route become attractive it is crucial to time the annuity purchase appropriately and research the best rates available at the time across a number of providers. Annuity rates can vary considerably according to the performance of financial markets at the time.
Ultimately the decision to take pension drawdown advice or rely on experience and/or readily available published information is a personal choice. Attitude to risk (and potential loss) and trust in the quality of advice all tend to be key considerations.
The information in this article does not constitute financial or other professional advice. You should not take action on the basis of this article without seeking regulated independent financial advice that addresses your specific circumstances. Past performance is not necessarily a guide to the future. You may not get back the full amount of your investment.”