Retired individuals investing for income drawdown need to alter the course of their portfolio strategy.
Since restrictions were lifted in April, everyone over the age of 55 has been free to manage their own pension investments and withdraw income as they see fit.
So where should individuals who shun the traditional annuity route invest their money to provide a decent level of income that rises over time?
Annuity buyers usually lock in investment gains well ahead of crystallising their pension by switching their fund into lower-risk investments, to reduce the risk of having to delay retirement or accepting a lower fixed income. But drawdown savers will want their fund to continue to have market exposure.
While individuals electing for drawdown may not need the same wholesale changes to their portfolio, they will need to review their investment strategy. As Ian Price, Divisional Director at St. James’s Place, explains, “With drawdown you don’t need to protect capital in the same way that you would before buying an annuity, but you do need to consider switching your strategy to place more emphasis on generating income rather than capital growth. Staying in the same investments you had at age 30 or 40 probably isn’t the right course of action.”
Freedom of choice
Drawdown savers have a more or less free choice when it comes to investing, including equities, bonds, commercial property and other alternative assets. Naturally, creating an appropriate drawdown portfolio shouldn’t be attempted without advice. It’s vital to ensure the correct blend of assets are selected to achieve the required objectives and that this strategy is reviewed on an ongoing basis.
For income-seekers, equity income funds that aim to generate a regular yield are often a popular source of income. The average 3–4% yield produced by such investments can provide an attractive income stream, while the capital remains invested.
Fixed-interest assets such as bonds and gilts typically represent a lower-risk option; but, in the current environment, investors have struggled to find attractive income opportunities as prices have been driven higher by the sustained period of low interest rates.
Indeed, the launch of two new fixed-income funds by St. James’s Place – the Diversified Bond and Strategic Income funds – was a recognition of the challenging backdrop for those seeking income in retirement.
“With the demise of final salary pension schemes and less state support, people increasingly need to make their own provision for their financial security,” observes Chris Ralph, chief investment officer at St. James’s Place. “These funds provide more options for those seeking sustainable and attractive levels of income. That said, it is vital that investors take advice to achieve the correct balance of investments within their portfolio.”
If you want more income than the natural yield produced by the fund, the only way is to sell units. To raise the necessary income in a falling market requires the sale of a greater number of units and will erode your capital quicker. Advisers will often recommend that clients have a buffer in cash to provide extra income and avoid the need to realise capital when share prices are depressed.
Price says that it may be better for those with less appetite for risk to look elsewhere. “If you’d rather not take a risk with your pension pot, then using it all for drawdown probably isn’t for you,” he explains. Price suggests that an annuity might be a better choice in some circumstances.
But Price adds that investors should not think of retirement as a choice between annuity and drawdown. “It’s not a case of one or the other,” he argues. “If you want security combined with something a bit more adventurous, you can receive fixed, guaranteed income from an annuity plus some flexible income from a drawdown plan.”
The value of an investment with St. James's Place will be directly linked to the performance of the funds you select and the value can therefore go down as well as up. You may get back less than you invested.
The level of income from Drawdown is not guaranteed. You may need to reduce your drawdown income in the future, in particular if the performance of your investments is lower than expected, or you live to a greater age than originally anticipated when choosing your initial income level.