The pension freedoms delivered a new option for many at retirement – flexi pension drawdown. Although pension drawdown offers a number of potential advantages it also has risks. Pension funds in drawdown funds could run out in retirement. An appropriate pension drawdown investment strategy is therefore essential.
For those with children, an ideal scenario may be to pass any remaining pension fund on to beneficiaries after death. The key drawdown fund investment management issues to consider are, therefore:
- Regularity of income
- Capital maintenance
Although a far from exact science you may wish to estimate how long you may live. Do you have any health problems, is your work life history likely to impact on how long you will live, what is your lifestyle, what is your family history? You may then put a basic plan in place with options should you live longer than you expect.
You may wish to minimise your drawdown on your pension funds by working for longer, on either a full-time or part time basis. You may even decide to continue to pay into your pension fund (up to specified limits) while you continue to work.
Before considering the pension drawdown option it is crucial to make a brutally honest assessment of your attitude to risk and your capability to monitor, control and make key investment decisions on a potentially significant pension fund over the long term. If you have a low-risk tolerance then drawdown should perhaps be avoided. If your investment management capabilities are limited then you may pay someone to take on this task on your behalf.
Diversification Minimises Risk
All investments carry risk. While it is impossible to eliminate the risk entirely and still maintain the income you require in retirement its impact can be reduced. With a diversified spread of investments, the impact of picking the wrong asset type, the wrong sector or the wrong region at the wrong time can be minimised.
The key issues are to set a balance that reduces risk but still provides an income. You may want to minimise risk by investing entirely in gilts but this is unlikely to deliver the minimum income you require. At the other extreme, more risky investments may deliver the income (and more) you aspire to in the short to medium term but may crash leaving you with a severely depleted retirement fund to provide an income over the remainder of your lifetime.
Regularity Of Income
it is reasonable to assume part of any pension drawdown fund will be used to deliver a regular income to cover bills and essential living expenses. However, it is important to note taking an income (drawdown) during market lows can have a major impact on the value of the fund that can be difficult to recover.
Markets rise and markets fall. Any investment (or range of investments) delivering high returns, followed by significant lows may deliver a satisfactory average level of return over the long term but, if a regular income is required, this option should be avoided.
It is wise to have some cash reserves (many recommend sufficient for 2 years) to avoid the need to take income from investments when at a low point. If cash is available investments can be allowed the time to recover before further income is taken.
A prudent strategy could be to maintain, as far as practical, initial capital in the face of inflation and/or government policy while relying on capital growth to deliver an ongoing income. The capital is then available to draw upon should you live significantly longer than expected or to pay any care costs that may apply in later life.
Any remaining capital may then be passed onto children after the pension holders (and their spouse) death. This can be one of the major advantages of pension drawdown as, unlike most annuity products the fund does not die with the pension holder.
Life expectancies are increasing and there is a risk that any pension drawdown fund that is not managed appropriately may run out during retirement. Making every effort to maintain the capital sum for as long as practical minimises this risk.
Building a pension drawdown investment strategy is far from straightforward. The balance between risk and growth is the key, combined with the flexibility to deal with whatever life (and the markets) may throw at you.
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The information in this article does not constitute financial or other professional advice. The value of investments can go down as well as up and you may not get back the full amount you invested. The past is not a guide to future performance. This blog is intended to provide a general review of certain topics and its purpose is to inform but NOT to recommend or support any specific investment or course of action.