Average drawdown withdrawal rates have reached a level unlikely to be sustainable through retirement
The FCA recently published new retirement income market data showing how consumers are using the pension freedoms. My initial reaction after reading the document was one of frustration, as the information only gives part of the overall picture. Providing some additional information would give a more comprehensive representation of what is going on. Having said that, there are some important – and sometimes worrying – findings.
The headline statistic shows the average withdrawal rate from drawdown pots, where a regular withdrawal is being made, has increased from 4.7 per cent in 2016/17 to 5.9 per cent in 2017/18.
A withdrawal rate of 5.9 per cent is unlikely to be sustainable over a client’s lifetime, especially when we factor in that many clients will be paying product, investment and adviser fees totalling between 1.5 per cent and 2 per cent a year.
Of course, the difficulty with averages is they hide a range of behaviours, so it would be helpful if the FCA also showed median or mode figures.
We need to remember that many clients will want a higher income in the early years of retirement, and they may be comfortable with this decreasing, in real terms, as they reach mid to late 70s.
The data also does not show how many of these people have other pension pots from which they are drawing no income, or a final salary scheme to fall back on.
The FCA splits withdrawal rates into five brackets and by pot size. These show a big fall in the number of pots where the withdrawal was less than 2 per cent a year. Withdrawal rates of more than 8 per cent are the most common for pot sizes of less than £100,000, suggesting many with relatively small pots are stripping money out of the pension quickly.
There may be an argument that this is reasonable behaviour, rather than taking what would be quite a small income from an annuity. However, it could mean people are paying more income tax than they need to, especially if the withdrawals are being made while they are still receiving earned income.
Product of choice
On a wider basis, drawdown continues to be the product of choice, with sales up 8 per cent in the second half of 2017/18 compared with the same period in 2016/17. However, total inflows are significantly up, growing 27 per cent, and the majority of this has been driven by new customers rather than by existing drawdown holders, with the average pot entering drawdown up from £105,000 to £123,000. This may well be driven by transfers out of final salary schemes.
And, while I touched on withdrawal rates above, it is worth noting 60 per cent of drawdown sales are cases where tax-free cash has been paid but no income taken.
Annuity sales appear to have stabilised, with new sales up one per cent from last year, while full cash withdrawals have fallen by nine per cent. Worryingly, the proportion of full withdrawals and annuities sold with advice has fallen to its lowest level since 2015/16. Only 28 per cent of annuities were advised sales, down from 34 per cent in 2017/18.
But there has been an increase in the take-up of guidance, including the government’s Pension Wise service. The proportion of annuity sales that were not advised but took guidance increased from 17 per cent to 30 per cent, suggesting it has become a more popular channel for annuity purchases. Drawdown fares better with 69 per cent of people taking advice – a figure that has been fairly stable over the past few years. However, this does mean almost one in three drawdown customers are trying to manage the numerous risks involved without the expert assistance of an adviser.
While 11 per cent of the pots entering drawdown without advice did seek guidance, the need for ongoing reviews makes this a much more difficult contract to provide guidance around than a one-off annuity purchase.
Worryingly, we are also seeing many people declining to take up guaranteed benefits – guaranteed annuity rates or deferred annuities. In the second half of 2017/18, almost six in 10 were not taken up.
While the overall retirement market trends suggest many people favour flexibility over certainty of income, the fact around 16,000 consumers passed up guaranteed benefits is a concern, as many provide income much higher than current annuity rates. It is worrying, and somewhat bizarre, for the FCA to say this information will no longer be part of its regulatory reporting.
While not giving the complete picture, this data is useful in helping understand how the market is developing since the pension freedoms were introduced. Much of the behaviour appears reasonable but we should not ignore signs that suggest there is still the possibility of some consumer detriment in the longer term.
Andrew Tully is pensions technical director at Canada Life