We need to talk about drawdown risk

Income drawdown has grown in popularity over recent years, and rightly so. It offers clients the opportunity to take their tax-free lump sum, while enabling flexible income withdrawals and the ability to stay invested. In theory, it is the answer to achieving a flexible and sustainable retirement income. But it’s not without risk. Here we discuss how and why you should consider de-risking your book of drawdown customers – especially those with funds under £200,000 and no other significant sources of income.

Data released by HM Revenue and Customs (HMRC) in January[i] shows that the average amount being withdrawn per individual from pension schemes has fallen steadily year-on-year since the introduction of pension freedoms in April 2015. HMRC has attributed this to clients phasing their withdrawals to minimise income tax, implying that fewer people are taking their pension savings as a lump sum. Meanwhile, data released by the FCA last year suggests the key benefactor of changing behaviour is pension drawdown. Their study found that in 2018/19, 70%[ii] of pension pots between £100,000 and £249,000 went into drawdown with an average investment of £147,500[iii], and 66% of this business was advised[iv].

How to de-risk your drawdown book 

Many customers in the £100,000 to £249,000 pension pot bracket are likely to be better off keeping their pension pot invested – especially if they are younger and need to protect themselves from longevity and the ravages of inflation. But, with 75% of drawdown plans accessed by people aged between 55 to 64[v] last year, advisers need to be mindful of the other risks at large. Of course, there’s the obvious issue of investment risk, but there’s also several potential dangers associated with the level and frequency of withdrawals, and from where those withdrawals are taken and when. While drawdown may well be the right solution initially, it’s crucial to continue to review the suitability on an ongoing basis.
The FCA is taking a keen interest in the fair treatment of retirement income customers and the product knowledge and reasons behind any product recommendation. While drawdown is an excellent solution for many, it’s important that advisers understand and document their clients’ positions on the following three questions – both at point of sale, and during regular reviews:

  1. What is the client’s capacity for loss?
    The FCA has stressed the importance of assessing a client’s capacity for loss. This can be defined as the amount of loss a client can bear and is an objective assessment. And different to a client’s attitude to risk, which is more of a subjective measure. There is much debate within the industry about how capacity for loss should be measured, although for many advisers a key tool will be the use of cash flow planning. It’s clear the FCA want firms to have strong, robust processes in place, both at outset and when reviewing ongoing suitability.
  1. How old is the client?
    Age is undoubtedly a factor when it comes to the ongoing suitability of drawdown. Nobody can predict how long they will live but the impact of ‘mortality cross-subsidy’ means annuities can become better value at older ages and as health declines. A full drawdown strategy may become progressively less suitable as customers get older and less healthy, although this will depend on client needs.
  1. What is the client’s withdrawal requirement?
    How and when the client wants to withdraw money from the drawdown plan should underpin the investment strategy. Clients who are taking a regular income, for example, could suffer badly if they experience poor returns in the early years of taking withdrawals. Equally, if they suddenly have a need to make a large withdrawal, that could also be damaging. An investment strategy geared towards appetite for loss, not gain, could potentially make their drawdowns last longer. A client could, for example, invest in a risk targeted fund range (say a Portfolio 3, Portfolio 5 and Portfolio 7), setting the monthly income to come from the lowest risk fund and then automatically rebalancing the pot back to its starting asset allocation.

How to set up a bucketing strategy

Alternatives to a drawdown-only solution

For clients with no other significant income stream, it may be worth considering a hybrid solution that involves guaranteeing their essential income expenditure (taking into account other income sources such as the state pension and any defined benefit income), while leaving the rest of the fund to grow. That could mean combining an annuity with a drawdown.

The Canada Life Retirement Account offers clients flexibility as well as certainty, at a lower cost than running two contracts concurrently. It allows clients to consolidate funds, continue to make pension contributions and accumulate pension savings, then seamlessly move into drawdown and access guaranteed income when they need it. The guaranteed income can be stopped or reduced if not needed to give tax control. All of this is underpinned by one of the most comprehensive investment propositions on the market.

The Retirement Account
For more information, or for help in de-risking your drawdown book,  you can email us or call us on 0800 912 9945.

Andrew Tully
Technical Director

Canada Life


[iii] Source: Calculated using data in Figure 2, www.fca.org.uk/data/retirement-income-market-data
[iv] Source: Figure 5, www.fca.org.uk/data/retirement-income-market-data
[v] Source: Calculated using the data behind Figure 4, www.fca.org.uk/data/retirement-income-market-data