My e-friend (have I just coined a new phrase?) Henry Tapper recently challenged how many people in drawdown really know what they are doing. Follow the link if you’d like to check it out for yourself.
If you’d prefer a tweet-sized summary, it’s that in drawdown avoiding a sizeable loss of capital is vital and that few have the investment skills to carry that off.
Drawing people’s attention to the risks they are assuming and what they’ll need to do – and avoid – is certainly doing them a favour. It’s good to go into things with your eyes open. I’ve seen people make a mess of drawdown; I’ve also seen them make a success of it. Some perspective is needed …
First, let’s be clear that while drawdown has been available to all since 1995, and while it has been a boon to SIPPs in particular, most people have bought an annuity with their pension savings, just as they did before drawdown was introduced.
Few of those people buying annuities take advice and consequently few take the open market option (OMO), greatly damaging their income in retirement in many cases. A much higher proportion of drawdowns, on the other hand, are entered into on an advised basis – and, of course, the option to buy an annuity later is still on the table.
In fact, perhaps my post should be titled “Annuities: you don’t know what you are doing!”. Again, I’ve seen first hand examples.
A year or so ago a friend bought an annuity with his personal pension fund. Did he ask me what he should do? No. Did he seek qualified financial advice? No. Why not? Because he thought it was obvious what he had to do: sign the form and send it back. Wrong!
In fact, very badly wrong. Never mind the benefit of shopping around for the best rate: he would undoubtedly have qualified for an enhanced annuity. And he’s lost out anyway since his pension credit has been reduced by an equivalent amount to his pension income. Game, set and match to the Treasury and the insurer.
Yes, with drawdown there are the risks of volatility and in particular the timing of volatility – early capital losses can potentially be a blow a fund never recovers from. But I have to contend that drawdown providers are doing a more effective job of explaining the risks than insurers are doing of explaining the risks of not identifying the most suitable type of annuity and not shopping around for the best rate (i.e taking the open market option). Otherwise, the vast majority wouldn’t be doing what my mate did: signing on the dotted line and sending the form back by return.
The government’s recent proposals on amending drawdown try to strike a balance between giving people freedom in how to use their pension funds (note the word “their”) and limiting the damage they can do. These proposals mean a choice between “capped drawdown” which will restrict the income that can be drawn to reduce the risk of the fund being depleted prematurely and a “freer” version only if the individual can meet a minimum income requirement (MIR). Of course, these don’t obviate disaster and don’t guarantee that individuals won’t have to make unplanned financial compromises later in life.
Finally, a little perspective on “getting it wrong”. In 2008 many experts found they’d “got it wrong”: their risk analysis, assumptions, probabilities, mathematical models and algorythms told them that packages of loans were AAA-rated. I can’t help suspecting if they’d asked Joe Average, he’d have said lending 120% LTV for people with no income, no job and no assets was daft.
And experts have “got it wrong” before when it’s come to questions of long-term interest rates, assumed investment returns, longevity and guaranteed annuity rates.
Joe Average may blow-up his drawdown fund with the next dot-com bubble (emerging markets, maybe, who knows?). But the experts are capable of blow-ups too (risk-based strategies driving investment in government bonds, maybe, who knows?). How about we give Joe Average the facts and let him decide?