A strong case can be made for forcing people who want to go into drawdown to take advice, says Nigel Orange, technical manager at Canada Life.
“Drawdown is an incredibly complex and important part of a retirement strategy,” according to Orange.
He believes that there is a case for introducing mandatory advice “when you consider the extent of the information required and the decisions to be made”.
Currently, defined benefit pension transfers involving a pot of more than £30,000 ($38,266, €33,620) must be advised.
This is not the case for drawdown, which involves keeping a pension invested and withdrawing funds while the pot of money, in theory, continues to grow.
“Failing to carefully consider and fully understand all the options and risks involved can, and is likely to, result in poor and, in some cases, disastrous outcomes.”
Without knowing the right questions to ask, people not taking advice (ie DIY investors) could view drawdown as a much more attractive option than it is for their particular circumstances and needs.
“Choosing the most suitable investment strategy is only one factor in the decision but will probably present a major challenge, especially for the novice investor,” Orange says.
Specific risks associated with drawdown
DIY investors are unlikely to be aware of the specific risks of opting for drawdown.
Orange has put together a list of the biggest pitfalls:
- Withdrawing unsustainable levels of income and prematurely depleting the fund.
- Living longer than anticipated and running out of income.
- The sequential risk of investing and withdrawing when markets are falling and using other sources of income to mitigate these events.
- Making poor investment choices that may not be aligned to risk profiles or meeting the key objectives of delivering a stable regular income.
- Withdrawing funds in an inefficient tax manner – for example, not using tax free cash.
- Inappropriate fund switching.
- Not making or updating death benefit preferences.
- Ignoring the ongoing option to annuitise when it may be most advantageous to do so – for example, if health declines or interest rates rise.
Key considerations
In order to address some of the risks outlined above, Orange has also compiled a non-exhaustive list of the key questions that advisers should ask clients before moving forward with a drawdown strategy.
- What the client’s objectives from the pension arrangement? For example, is it for holistic planning, tax mitigation, supporting an existing lifestyle or simply paying for basic living costs.
- What are the basic living costs and how will these be met if drawdown income runs out?
- Is tax free case required now and, if so, is it all or part?
- Does the client need guaranteed income or income provided through investing?
- What level of income is required, and will this change?
- If there is other retirement income and capital available outside the pension arrangement, how accessible does it need to be?
- Is downsizing or equity release an option later in retirement?
- Other than the client, who may be dependent on the pension income?
- Are there any health issues and what is the expected longevity?
- What is the client’s risk profile and capacity for loss?
- What investment strategy is preferred?
