Since A-Day on April 6, 2006, our firm has experienced an increased level of demand forincome drawdown. This may be put down partly to a larger number of enquiries from savvy high-net-worth investors but also simply the ability to take tax-free cash without being forced to draw an income.
Recently, our advice to use income drawdown rather than opting for the more traditional option of an annuity purchase has been a result of market volatility. Rather than crystallise losses within a pension fund at a time when intense periods of volatility make any investment timing decision incredibly difficult, we are starting to see the distinct advantages of using income drawdown as a method of avoiding that annuity purchase judgement call.
Existing clients would have been receiving advice for several years before their intended retirement date to move their holdings out of equities gradually and into less volatile asset classes, assuming that annuity purchase was the likely retirement option to be selected. It is those who come to us a month before retirement with a fund still fully exposed to global equities that require a different approach.
Investment risk is a pretty sound reason for avoiding income drawdown in most circumstances. Looking at the important risk warnings that we highlight to all investors considering this option, investment risk makes a frequent appearance. We tell clients that investment returns may be less than those shown in the illustration. We also tell them that high levels of income withdrawal might not be sustainable and this warning is directly linked to investment risk.
One benefit of the recent stockmarket volatility has been increased levels of risk awareness. Part of our ongoing commitment to providing a review service to existing clients is to regularly assess their attitude towards investment risk, reward and volatility. These attitudes naturally alter over time and investing money during volatile market conditions can do interesting things to risk profiles.
You might assume that risk profiles would trend downward towards the more cautious end of the spectrum at a time when the FTSE 100 is engaged in high-wire acrobatics, arguably without much of a safety net. This is often the case but some clients defy expectations and takethe opposite approach.
The current market conditions actually make it easier to identify the real risk-takers among our more adventurous clients.
What current investment market conditions do tell us is that a full and frank discussion about all options and issues related to at-retirement planning is essential. It would be irresponsible to adopt a standard approach to retirement planning advice at a time of non-standard market conditions.
Used as a short-term home to avoid being forced into crystallising investment losses, income drawdown does not have to represent a high-risk option. I would argue that, other than changes to the taxation of death benefits and the risk of annuity rate changes, there is little difference between an invested pension fund pre-retirement and the equivalent fund post-retirement.
What it does provide is the opportunity to move gradually out of a high-risk volatile portfolio and into something less risky, ready for annuity purchase at a more appropriate time.
The alternative is for the IFA or their client to make the mother of all judgement calls and try to time the market on a particular day. An IFA is rarely well placed to be able to guess what happens next to a particular asset class in the short term. We are frequently told by the investment experts that time in the market is more important than timing. This wisdom is particularly relevant when it comes to making the decision to move intocash at retirement. This decision will have a long-term impact on the level of income available to your client until the day they die.
For as long as clients neglect proper financial planning in the run-up to their intended retirement date, the approach of using income drawdown as an interim retirement option will remain relevant. It gives clients access to their tax-free cash, starts the stream of income and provides a breathing space during which funds can be phased gradually towards less volatile asset classes.