Earlier this week, we reported that this year's average pension fund performance could end up in negative numbers. For those who aren't sure what this could mean for their own pension, we've asked Moneyfacts Head of Pensions Richard Eagling to clear up some confusion around this difficult topic.
With people living longer and inflation still reducing the value of our wallets, it's important for anyone nearing retirement to make sure they have enough stashed away to last, no matter what happens to their health or the economy. Key to this is ensuring a sustainable retirement income, as this will likely be the only income – aside from the State Pension – that most people will have to rely on after they stop working.
"Pension value falls in the early days of taking an income can have a devastating impact on retirement income sustainability," Richard explained. "As a result, it is absolutely crucial that investors have some understanding of these risks or have access to an adviser who can monitor these risks and provide the necessary help and support."
Since the pension freedoms, people over 55 can access their pension funds and take out as much as they like, with the first 25% taken as a lump sum being tax-free. Without proper advice, someone might be tempted to withdraw their entire pension fund at the first sign of negative returns. However, putting these funds in a regular savings account would likely result in a much larger loss of interest, not to mention a potentially hefty tax bill.
That said, withdrawing money from your pension in a measured, controlled manner – through drawdown – is one of the two main types of ways to get pension income (annuities being the other one, although providers are now coming out with hybrid solutions as well). In simple terms, drawdown allows retirees to take an income from their pension while leaving the rest invested to keep gaining interest.
"When retirees begin withdrawing money from their pension, the sequence of investment returns can be crucial to the prospects of providing a decent long-term income," said Richard. "Research from Zurich earlier this year suggested that a third of retirees relying on drawdown are first-time investors. This is incredibly frightening, particularly as many do not use financial advisers. To expect individuals with no stock market experience to be able to manage their own, very often inadequate pension pots and take a realistic income for an indeterminate length of retirement is highly optimistic, to say the least."
In contrast, using your pension pot to get an annuity would result in a set income for the rest of your life – however long that may be. Despite this, due to annuity income often falling below the potential income that could be gained through drawdown (depending on all manner of personal circumstances such as the size of the pot and the pension funds people are invested in – again we can't stress enough the value of seeking personalised professional advice), drawdown is currently the more popular option.
If you're willing to take the risks of drawdown, Richard has suggested some steps "that investors can take to help safeguard themselves against market falls impacting their drawdown strategies":
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