Understanding the Risks of Pension Drawdowns

What Are the Risks Associated With Pension Drawdowns?

There are various risks associated with pension drawdowns that your retirement planning should bear in mind, including:

Risk That You Might Run Out of Money

Of course, one of the major pension drawdown risks is that having unfettered access to your savings can mean that you may eventually run out of money if you are not careful.

Many people underestimate how long they might live, withdrawing unsustainable amounts of income that could leave them with a shortfall in later life.

Poor Investment Returns Can Reduce Your Income

The unpredictability of the stock market means that investments can go down as well as up, which means that you could receive less than you put in.

As such, poorly performing investments can erode the value of your pension. For that reason, it is essential to take financial advice to ensure you spread the risk effectively.

Requires Careful Management of Investments

While some pension savers may enjoy the opportunity to take some control over the investments tied to their pension drawdown arrangement, the potential for investment losses makes it essential to keep regular tabs on the performance of your investments to ensure they remain on track.

Annuity Rates May Provide More Income in Later Life

Some people may find that an annuity or enhanced annuity is better for the longer term. With an enhanced annuity, providers take a gamble on your life expectancy. Therefore, if you have health issues it may pay to take out an annuity.

Plus, if your money is still invested, the government could say you need to use your savings to pay for medical or residential care. Whereas, with an annuity, that money is already spent. So you may not have to pay out from your assets.

Various Charges and Fees to Keep In Mind

The flexibility of pension drawdown comes at a price. Pension drawdown providers often levy various charges for the privilege.

Some of those charges may include setup fees, administration charges, exit and transfer fees to name but a few. So it pays to shop around to ensure fees and charges don’t erode the value of your pension.

Learn more about Hilltop’s Pension Drawdown advice.

 

What Are the Tax Implications of Pension Drawdowns?

It is worth noting that any income you take from your pension above the initial 25% is taxed similarly to income earnings. Therefore, Pay As You Earn (PAYE) tax is deducted from your pension income before it is paid to you.

However, the major benefit of using pension drawdowns is that you can control the amount and frequency of your withdrawals. 

With that in mind, you can minimise your tax burden by keeping your withdrawals within the personal allowance or a 20% basic tax rate wherever possible.

 

What Is Longevity Risk, and What Impact Can It Have?

Longevity risk is the very real possibility of outliving your pension funds and any other investments or capital. Although life expectancy in the UK lags behind most other G7 countries, many pensioners still underestimate their life expectancy.

Research by Vitality found that if a retiree on an annual drawdown income of £13,862 lived five years longer than they had envisaged, they would be left with a pension shortfall of £50,000.

Therefore, it is important not to live beyond your means – particularly in your early retirement years.

 

How Does Inflation Affect Pension Drawdowns, and What Can I Do to Protect Against It?

Typically, low inflation enables a pension fund to grow at a faster rate than inflation over time. However, high inflation rates will generally stall the growth of a pension fund, eroding the value of the pension pot.

This is perfectly normal, and all long-term investments are subject to fluctuations over the course of their lifetime. 

To mitigate periods of high inflation and rising living costs, as we are currently experiencing, one option is to diversify investments across cash, stocks and bonds.

This approach can spread the risk and provide security over the short, mid and long term. Another option is to pause your pension drawdowns and take income from tax-free investments, like ISAs, until inflation stabilises once more.

Before making any decisions or changes to your pension or income strategy, it is always wise to speak with a fully trained financial professional.

 

What Is Sequence of Returns Risk, and How Does It Impact Pension Drawdowns?

A sequence of returns risk or sequence risk is the threat of your pension savings being exposed to the poorest returns at the most inopportune time.

That threat is at its greatest as you transition from the accumulation phase in employment to the decumulation phase of drawing an income from your pension in retirement. 

This is because a market downturn that results in low or negative returns on what is likely to be a sizeable pension pot by that stage can erode its overall value, with considerably less time to make up the difference compared to someone at the beginning of their pension saving journey. 

Therefore, it is vital to seek the retirement planning advice of a financial adviser before clocking off forever to ensure your retirement nest egg is as healthy as possible and isn’t unduly affected by sequence risk.

 

Get Pension Drawdown Advice At Hilltop Financial Planning

Pension drawdowns provide retirees with a flexible means of drawing a retirement income to suit their needs. However, there are some inherent pension withdrawal risks associated with income drawdown.

Not least the very real threat of pension fund depletion at the hands of market fluctuations, sequence risk and overspending. 

However, our advisers at Hilltop Financial Planning are here to give you all the facts you need to make an informed decision about whether or not pension drawdowns are a suitable option for you.

If it makes sense to go down that route, a combination of careful planning and sustainable withdrawal rates are the key to success.

We can formulate a robust pension drawdown strategy and help alleviate investment risks in retirement, minimising the chances of running out of funds.

Contact us to learn more about the benefits and risks of pension drawdown and how the Hilltop team can help you plan for a secure financial future. Get in touch today at 0161 413 7051.