If you opt for income drawdown in retirement as opposed to an annuity (guaranteed lifetime income), you’ll need to think carefully about your withdrawal strategy. You’re now at the point in your financial life when you’ve reached the peak of your savings journey. Until now you’ve been on the accumulation stage, amassing wealth, but now it’s time to start drawing down on the assets. The trick is to make the income you take last your full retirement and not run out before.
Savings and investment for retirement may have taken various forms. Pensions, ISA’s even a buy to let property. You net worth has climbed though out your working career but now it’s time to enjoy the fruits of your labour.
The new pension reforms have shifted the landscape with how people look to enjoy their savings. Annuities were straight forward. Hand your pension fund over to an insurance company and then receive a lifetime income. The improving life expectancy and depressed gilt rates have obliterated the value of these in recent year however. Income drawdown has become favourable because of the flexibility it offers. Having unrestricted access to your fund, giving it a chance to continue to grow by keeping it invested and importantly being able to pass any unused fund to your estate are major plus points. The downside however comes in its complexity.
Many people aren’t used to making investment decisions. Certainly with the largest savings pot they’ve probably amassed. The decisions made now will affect the rest of retirement. Here are 5 things to think about before jumping into income drawdown.
Complete a risk profile. Your attitude to risk changes in retirement so it’s important to understand where your money is invested and what are the probable returns of your portfolio. Being ill informed about the volatility of a portfolio may lead to some nasty shocks which your financial situation may not be able to tolerate.
Hold a cash reserve. Stock markets go both down as well as up. If you have all your savings in the markets and they take a dip, you’ll be pulling out units before they have chance to recover. Holding a cash pot which can be used in declining markets will provide some buffer to volatility. Gains in future years can be used to replace the cash reserve.
Do a budget planner. Having an idea what your outgoings are is essential to making your income drawdown pot last. Think about spending now and how this may change in future years. Usually the need for income is more in the immediate years after retirement, it may lower in mid retirement but care home costs may bring this back up at the end. Research has suggested that taking 4% from a drawdown plan is a sensible way of providing some sustainability.
Understand income tax. Any money withdrawn after you take your tax free lump sum is added to your annual income tax allowance. Therefore if you take advantage of the unrestricted withdrawals and take a large amount, this may be taxed at a higher rate initially. HMRC will treat the payment as a potential monthly payment rather than a one off lump sum and tax it accordingly. Royal London have summarised how to reclaim this here.
Review your portfolio regularly. Keep close to how your investment is doing. Where it’s invested, what the returns are and what affect your withdrawal are having on its sustainability. If you’re using a financial adviser they should be reviewing this at least annually with you. You attitude to risk may change, your financial needs or personal circumstances may change. Make sure your drawdown plan is doing what you expected it to and is complementing your retirement not reducing the quality of it.
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