Pros & Cons of Pension Drawdown and QROPS

Published: 29th November 2011
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Britain has experienced unprecedented stock market turbulence in recent years – and the value of many income pension drawdown investors' pension pots has plunged. That is bad enough but those who continue to take high withdrawals could see up to 80pc of their pension savings wiped out within just six years. This is based on an investor with a £250,000 pension pot who took an income of £21,600 each year from 2000-2006 despite falling markets.

However, the stock market's strong rally this summer demonstrates that share prices can rise as well as fall without warning – and that the past is not necessarily a guide to the future.

Pension drawdown allows people to take an income from their pension savings while leaving it invested in the stock market or other allowable investment. It is an alternative to an annuity – which involves you handing over your pension savings to an insurance company in exchange for a guaranteed annual income for the rest of your life.

Large numbers have invested in pension income drawdown since this new option became available to pensioners in 1995. Since QROPS became available in 2006 nearly £1.5bn has transferred overseas alone.

Typically these funds are invested in a combination of shares, cash and fixed-interest investments such as bonds and gilts. But experts are urging income pension drawdown investors to consider temporarily stopping or reducing withdrawals if stock markets suffer another severe correction, to avoid their pension capital being eroded. The amount of income an investor withdraws is now reviewed every three years, but pension drawdown investors may wish to make more frequent assessments of their situation.

If someone is taking income from their income drawdown contract in a falling market their pension savings could be whittled away alarmingly rapidly.
Take a 15% fall in pension fund value (the FTSE 100 fell from 6024.00 to 5102.60 in the three months to 5th September 2011) and an investor taking 5% income on 5th September 2011. That’s a 20% fall in capital value which will require a 25% return to recover.
The regular catchphrase ‘investments can fall as well as rise’ perhaps doesn’t convey that a percentage fall isn’t recovered by the same percentage rise.

As a general rule, you should try to keep your withdrawals within the natural yields on your investments – for example, the interest made on cash, the dividends paid on equities and the rental income from property. This way you will not be eating into your capital.

The majority of income pension drawdown providers allow you to specify which assets you want your income to be drawn from. Where circumstances dictate selling assets, take advantage of this flexibility to encash the assets that carry the lowest risk first – cash and Government gilts. This way you should avoid crystallising stock market losses by selling shares after prices have fallen.

If someone is invested in equities care is needed in crystallising their paper losses into real losses by taking an income from them.

If they have a mix of cash, corporate bonds and equities in their income drawdown contract they should draw from the cash element to give the riskier assets a chance to recover.
But income pension drawdown does not always have to be risky. For example, you can have your fund invested 100% in cash. As long as your money is spread across different financial institutions this strategy bears little to no risk but is unlikely to sustain high income in the long term.
Third way products providing capital guarantees are also available via pension drawdown and QROPS and for many now provide the optimum balance between investment returns and capital security.

Another upside to income pension drawdown and QROPS is that you retain control of your money, which means your partner or dependants will be able to benefit when you die – whereas, with an annuity, the insurance company keeps your cash.
Income drawdown lets you take 25% of your pension savings as a tax-free lump sum when you set up a contract even if you do not want to draw an income straight away and it is also extremely flexible – you can turn your income tap on or off at any time – which makes it a good option for people who retire gradually or have other income sources.

But if the credit crunch has given you the jitters you can always take your pension savings out of income pension drawdown and buy an annuity.

While income pension drawdown enables pensioners to retain ownership of their capital and some degree of choice about how and when they draw income, annuities provide a guaranteed income for life; in return for immediate loss of capital.
QROPS of course for the qualifying UK expat provide the added advantage of 100% distribution of residual funds on death whereas the UK pension drawdown will suffer a 55% death tax charge.

It is a difficult choice to make at a time when many people will have other things on their mind and world economics are so volatile and unpredictable – but at least people are now allowed to choose, rather than having to put up with the extra restrictions, which used to apply, on how they access their savings.

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