Since Pension Freedoms were introduced in 2015, more retirees have opted to access their pension in a flexible way. However, while it can be beneficial, using Flexi-Access Drawdown means you have to remain engaged with your savings throughout retirement.

Statistics from the Financial Conduct Authority (FCA) demonstrate that Flexi-Access Drawdown has become an integral part of the retirement jigsaw for many. Between October 2017 and March 2018:

  • 90,504 pensions entered drawdown for the first time
  • This compares to 33,975 new Annuity sales

In the past, purchasing an Annuity was the most common way for retirees to turn their pension into a retirement income. An Annuity delivers a guaranteed income for the rest of your life, which is often linked to inflation. However, it doesn’t provide the same level of flexibility that drawdown does, a feature that the figures suggest modern retirees are keen to take advantage of.

In contrast to an Annuity, Flexi-Access Drawdown allows retirees to take an adjustable income from their pensions, while the rest typically remains invested. As modern retirement means income needs may change significantly, the ability to increase, decrease or halt withdrawals can be useful. It provides retirees with more control.

With more retirees favouring the adaptable income that Flexi-Access Drawdown offers, it’s important to be aware of the potential risks and why remaining engaged is important. Among the challenges of using Flexi-Access Drawdown are:

1. Withdrawing unsustainable levels of income

The key thing to keep in mind if you choose Flexi-Access Drawdown is that you’re responsible for withdrawing an income and ensuring it continues to support you throughout retirement. It’s crucial to ensure the withdrawals you make are sustainable and consider the long term. For example, does your withdrawals rate allow for potential care costs in the future? Will you reduce lifestyle spending as you approach your later years or maintain it?

As a result, it’s important to keep an eye on how the withdrawals you make affects the overall value of your pension. This will depend on a range of areas, including the performance of investments. Running out of money in retirement can be a risk when using Flexi-Access Drawdown if you haven’t planned how or when you’ll take an income.

2. Longer life expectancy

Your life expectancy is an important part of calculating a sustainable withdrawal rate when using Flexi-Access Drawdown. However, it’s a figure that many underestimate, potentially placing their future financial security at risk.

Research from the Institute for Fiscal Studies (IFS) indicates that those in their 50s and 60s will, on average, underestimate their chances of surviving to the age of 75 by around 20%. National statistics suggest men born in the 1940s have an 83% chance of making it to the age of 75, for women it’s 89%. Thanks to improving life expectancy, it’s not uncommon for retirement to last 30 or even 40 years. Clearly, if you’ve planned for your retirement to last just half what it does, you could be setting yourself up for real financial difficulty in the future.

As a result, thinking about how long your retirement could last, along with your overall health, is an important factor when using Flexi-Access Drawdown.

3. Investment risk

When using Flexi-Access Drawdown your retirement savings will typically remain invested. This gives your provisions an opportunity to continue generating returns even as you access them. However, this does mean you’re still exposed to investment risk.

All investments carry a level of risk and you’ll usually have several risk profiles to choose from. This allows you to select one that matches your attitude to risk, investment time frame and retirement plan.

During your retirement, there will be periods of volatility; this should be factored into your plan. If you make a withdrawal when the value of your investments has dipped, you’ll need to sell more stock or shares to achieve the same level of income. As a result, reducing or stopping withdrawals where possible during these periods can help preserve your pension.

4. Inflation

Inflation eats into your savings, reducing your spending power over time. While many Annuities are linked to inflation, providing a layer of protection, this isn’t the case with the withdrawals you make when using Flexi-Access Drawdown. As the money remaining in your pension is invested, you hope the returns generated outpace inflation. However, there’s no guarantee of this. While inflation is out of your control, being aware of how it may affect your income, and therefore lifestyle, should investment performance fail to keep up is important.

5. Tax efficiency

While you can access the savings held in a Flexi-Access Drawdown product as and when you like, one area you may not have considered is tax. Withdrawals from pensions are subject to Income Tax once you pass the annual Personal Allowance, set at £12,500 for the tax year 2019/20.

As a result, making higher withdrawals during a tax year could mean paying far more in Income Tax if you then reach a higher band. This is something to keep in mind when planning when you’ll make withdrawals over the course of the year and how much to take depending on other sources of income you’ll receive.

If you’re using Flexi-Access Drawdown or are considering this option at retirement, we’re here to help. If you want support in understanding how your pension can deliver an income throughout retirement, please get in touch.