Figures showing a sharp rise in the number of pensioners choosing income drawdown plans raise questions whether retirees are making bets they can’t afford to lose, Just Retirement has warned.
The retirement income specialist is concerned that the lessons learned about volatility in financial markets, clearly demonstrated by events following the collapse of Lehman Brothers six years’ ago this week, are being forgotten with new ‘pension freedom’ rules allowing some retirees to make over-ambitious investment choices.
“The latest figures from the ABI show that sales of annuities which offer a guaranteed income for life have fallen, while sales of income drawdown contracts have soared,” said Stephen Lowe, Just Retirement’s group external affairs and customer insight director. “It seems that people who once would have been discouraged from taking investment risk with pension money are now opting for plans that are likely to be more risky and complex. It looks like a triumph of hope over experience.
“There’s no problem with people taking more investment risk if they can afford to ride out the ups and downs. The problem comes when people are relying on those investments performing in order to pay day to day living costs, because history tells us that asset prices fall as well as rise.”
Stephen Lowe said that those relying on a pension income need a different mindset to those still working and building up a pension. “The primary focus needs to be capacity for loss and not expected returns,” he said.
“When you regularly drip feed money into a pension you take advantage of asset price volatility, buying more if prices fall and benefiting from ‘pound cost averaging’.
“But this goes into reverse if you have to sell assets to generate income when the market is stagnant or falling. Because you are starting with fewer units, you need a much stronger recovery in asset prices to get back to where you started. In 2008, the year that Lehman’s collapsed, the total return on UK shares was minus 30 per cent and many other asset prices fell too, striking fear into drawdown investors who couldn’t afford to sit out the turmoil.”
He said that however prudent, experienced or lucky investors are, they still don’t know what may lie just around the corner or how long their pension fund will need to pay out. It is only by securing a core of guaranteed lifetime income – from State Pension, annuities or final salary schemes – sufficient to pay the bills that they secure the freedom to invest, spend or
give away any remaining funds.
“Investment and longevity risks are ones that individuals find it very hard to cope with and exactly the reason annuities were invented in the first place. With an annuity you can spend the income without worrying if it will dry up tomorrow.
“Under the new rules, our worry is too many people will start risking money they can’t afford to lose. How would we know if that were happening? Well the first sign would be a sharp rise in income drawdown sales, with the popularity of annuities falling, which is why we are drawing attention to the potential downside of these latest figures.”
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