Everything you need to know about income drawdown in a volatile market

AFTER decades spent diligently saving into your pension pot, the suggestion that a falling stock market could put a serious dent in your lifetime’s savings is nothing short of a nightmare scenario. However, as scary as it sounds, there are some simple steps you can take – even in times of the most unpredictable market volatility – to ensure that you keep your retirement income intact.

1. Resist the temptation to run

When you read about markets falling and prices tumbling, it’s usually the main market indices that are affected. But odds are that you won’t be 100% exposed to falls in the equity market. In a well-diversified pension pot, you’ll have investments in a mix of assets, from bonds to cash, commodities, like gold and even property. Often when one asset is doing badly another may be doing better, so keep your own pension pot in perspective. Headlines screaming ‘millions wiped off shares’ are alarming, but they don’t give you the full picture.

At the beginning of the pandemic in 2020, there was an initial increase in the number of people withdrawing from their self-invested personal pensions – the vehicle utilized to eventually access drawdown. The initial shock of the pandemic led to many wanting to access their funds in order to create a safety net for themselves or family members. Looking back now it was those that remained invested that benefited from the ‘V-shaped’ recovery.

By making knee-jerk decisions in times of turbulence you can easily lose money and miss out when markets regain their composure.

2. Make sure you know about the MPAA trigger

Some of the most common questions from our SIPP customers are about the Money Purchase Annual Allowance (MPAA). As soon as you start to take an income from your pension you trigger the MPAA and that means you can only make further contributions of up to £ 4,000 a year into your pension for ever after. That is why this is something particularly important for anyone thinking about phasing their retirement and continuing to work part time, as it effects the amount you are able to continue to save into your pension.

Charlie Nicol, Associate Director Retirement Advice at Fidelity, says: “Before moving into drawdown, consider using guaranteed income sources. These could include income from a defined benefit pension, an annuity [for more on that see below] or your state pension. “

The idea, he explains, is to at least meet your essential expenditure.

3. If you’re using drawdown, think twice before making withdrawals

The main attraction of drawdown is the control it gives you. So even while the markets may feel uncertain, don’t forget you can regain some certainty by switching-up your investment decisions.

Leaving your investments intact is one option. You could stop withdrawals when markets are lower and avoid losses. If you need cash, you could stick to withdrawing only the income generated from your investments. Either way you don’t suffer the consequences of selling investments on a low.

Fidelity’s Nicol recommends keeping your gross withdrawals as low as possible. He says withdraw an income as tax-efficiently as possible, making sure you utilize any unused tax-free cash and unused personal allowances.

4. Don’t crystallise your losses

With drawdown you can take 25% of your pension pot in cash, tax free, or you can take 25% of every withdrawal tax-free – either way you do it, this is known as UFPLS. An unhelpful acronym that stands for Uncrystallised funds pension lump sums (UFPLS) it gives you a way to take pension benefits from your pension, without going into drawdown or buying a lifetime annuity.

Under the UFPLS option, you can take your uncrystallized pension funds in one go, or as a series of lump sums. It’s also possible to combine UFPLS with other benefit options – for example, you might take an UFPLS from part of your pension fund and use the rest to buy an annuity to provide you with a guaranteed income.

Interestingly, at Fidelity we have seen the number of SIPP customers who decide to take the maximum amount of tax-free cash, partial tax-free cash and UFPLS all remain the same. But, because of market volatility, we have seen that customers are currently less likely to transfer or consolidate their pensions right now, as they want to avoid the risk of transferring and end up doing what we’re trying to avoid here – crystallising a loss .

5. Use your cash buffer

This can be the time when your cash savings come into their own. Having access to cash means you can avoid selling investments at a loss or when markets are down. That is why the suggestion is that you keep up to two years’ expenses in cash, so should markets become unpredictable you can leave invested assets alone and use your cash savings as your volatility safe-haven.

Nicol recommends maintaining a decent emergency cash fund with at least six but preferably even 12-24 months’ worth of emergency income in it, to avoid having to sell in a falling market. And review your spending. Do you still need the same regular income? Are there any areas you can cut down on? He says, where possible, reduce your drawdown withdrawals to only what you need.

6. Consider buying an annuity

With an annuity you get an income for the rest of your life. And now could be a good time to buy one, if that’s something you’ve been considering. That’s because you lock in the rate you get on the day you buy the annuity, so buying when rates are high is obviously preferable.

When interest rates go up, so too do annuity rates. So right now, after the recent interest rate rises, and more expected, it could be a good time to buy. Of course, it’s not as simple as the annuity rate alone; the factors that determine exactly what you will get vary widely from person to person, with age, gender, health and choices like whether to opt for inflation protection, affecting how much fixed income your money will buy you, quite considerably.

And don’t forget, you could take a blended approach and use just some of your pot to buy an annuity, giving you some certainty around part of your income and the choice to buy another annuity later if that works for you. In the meantime, you can keep the rest of your pension pot invested.

7. Take financial advice

When it comes to your pension pot and making sure it will give you the lifestyle you want, avoid taking unnecessary risks, or cutting corners. Now could be a good time to consider taking professional advice. An adviser can help you navigate the ups and downs and share their expertise when it comes to how best to manage your pension savings and investments. There may be a charge for this, but the peace of mind this brings can be invaluable.

The Government’s Pension Wise service offers free, impartial guidance to help you understand your options at retirement. You can access the guidance online at www.moneyhelper.org.uk or over the telephone on 0800 138 3944.

Fidelity’s Retirement Service also has a team of specialists who can provide you with free guidance to help you with your decisions. They can also provide advice and help you select products though this will have a charge.

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