• This is the first bear market since the pension freedoms were introduced in 2015 with the FTSE All-Share having fallen over 20% from its most recent high
• While retirement savers should not panic in the face of short-term volatility, the turbulence emphasises the ‘pound-cost ravaging’ risk facing drawdown investors
• AJ Bell analysis shows the dramatic impact a 20% fall in markets can have if it occurs in the first year of someone entering income drawdown
• Based on an investor with a £100,000 fund taking a 5% annual inflation-adjusted* withdrawal:
o Where they enjoy a steady 4% annual investment growth, their pension will run out after 25 years
o Where they are hit with a 20% loss in Year 10 and enjoy 4% growth otherwise, their pension runs out after 21 years
o But where the 20% loss is recorded in Year 1 and they enjoy 4% growth otherwise, their pension runs out after just 18 years
Tom Selby, senior analyst at AJ Bell, comments:
“We have just entered the first bear market since the pension freedoms were introduced in 2015. People relying on their pension fund to produce an income in retirement are perhaps the most affected by such sudden market falls.
“Anyone making a withdrawal from their pension while also suffering a hit on their underlying investments will struggle to make the money back, meaning they may have to reduce their income now or face the prospect of running out of money sooner than expected.”
Pound-cost ravaging
“The difference in retirement outcomes as a result of the timing of negative investment returns can be significant.
“Someone taking a 5% inflation-adjusted income from their fund who suffered a 20% hit in their first year in drawdown could see their pension pot run out after 18 years – three years sooner than if they suffered the hit 10 years into retirement.
“By contrast, someone who enjoys 4% growth throughout their retirement could take the same income for 25 years.
“To put this into context, whilst on average life expectancy at 65 is 18.6 years for men and 21 years for women, a man has a 1 in 4 chance of living another 27 years, while a woman has a 1 in 4 chance of living another 29 years**.
“This is exactly why drawdown investors who are taking an income from their capital need to build a sustainable withdrawal strategy and review that strategy regularly. These reviews should occur at least once a year, ideally with the help of a regulated financial adviser.
“Anyone who is in the early stages of drawdown who has seen the value of their fund plummet should keep calm but not stick their head in the sand. If markets do not recover in the short-term, it may be necessary to reduce income withdrawals in order to ensure you aren’t risking retirement ruin.”
Top tips to reduce the risk of ‘pound-cost ravaging’ in drawdown
1. Review withdrawals and investments regularly to make sure your retirement income strategy remains sustainable.
2. If you have any cash investments, consider drawing on these first rather than selling down your capital to fund your retirement. This will give your underlying investments better opportunity to recover value after a market dip.
3. Using just the ‘natural income’ your investments produce can also mitigate the risk of pound-cost ravaging, although you may have to accept a variable income as a result.
4. Don’t panic buy / sell investments based on short-term, uncertain market volatility – this risks layering on costs without any guaranteed benefit.
