Using the pension freedoms? You could run out of money after just 16 years
Nearly one in three people could run out of money in retirement, robbing children of their inheritance, according to worrying new research. Traditionally, most pensioners bought an annuity at the point of retirement to guarantee an income for life, even after the introduction of “income drawdown”, which allowed you to leave your money invested and decide your own level of withdrawals.
However, that all changed two years ago, when the Government introduced the “pension freedom”, which permitted pensions to be withdrawn at any time and in any amount.
After the introduction of the freedoms – which in effect made income drawdown the default choice for most pension savers – sales of annuities plummeted by more than 90pc, from about 354,000 a year in their heyday in 2008 to 30,400 for the year to June 2016, according to the latest data from the City regulator.
But now, advisers and pension firms are becoming increasingly concerned that the shunning of annuities could be storing up problems for the future.
Not only may many thousands end up having nothing to live on in later life, they may also have to resort to raiding their other assets, such as the family home, wiping out the very inheritances they were so anxious to protect.
Chris Noon, a senior partner at Hymans Robertson, the pensions consultancy that carried out the new research, said: “We know the future is uncertain, so we can’t predict with any certainty whether an annuity or drawdown is better, or which investment strategy will serve pensions better than another.
“So we decided to look at every possible scenario, and examined thousands and thousands of potential outcomes.
“There are many good reasons why people should opt for drawdown, or another retirement strategy. But we wanted to examine the best option if your priority is to ensure you do not run out of money during your lifetime.”
Hymans analysed more than 5,000 different retirement scenarios and assessed how drawdown would perform compared with buying an annuity using a vast range of different investment outcomes. In an astonishing 30pc of drawdown cases, the money ran out before the individual died.
“The biggest surprise was that in so many scenarios the money simply ran out,” Mr Noon said. “This led us to
Sconclude that, while drawdown may be suitable for some people, many may be seriously underestimating the risk it can pose.”
Tom McPhail, head of pensions policy at Hargreaves Lansdown, the investment firm, agreed. He said: “We try to encourage clients to guarantee that they can cover their basic outgoings via an annuity and to make sure their spouses will be financially secure. After that, by all means go into a drawdown.
“Otherwise, if you avoid annuities altogether, there is a significant risk that the money will run out and your standard of living will fall as you try to survive on the state pension. Most will have no choice but to sacrifice inheritances by taking equity out of their property.”
Another concern is the sharp drop in the number of companies that sell annuities, with the market now dominated by three giants, Canada Life, Legal & General and Aviva, with Scottish Widows and Just selling “enhanced” annuities, which pay better rates to those in poor health.
Mr McPhail said: “We could end up with so few companies that there simply aren’t enough to provide a competitive market.”
The Hymans research concluded that, depending on how long you live, some investors would be left with nothing in the bank whether they adopted a safe, a medium-risk or a high-risk investment strategy.
For example, Hymans considered a 65-year-old man with £100,000 to invest. He could buy an annuity today, paying £5,500 annually until he dies, while the number crunchers also examined various drawdown strategies and how they worked out over 35 years.
Mr Noon said: “The drawdown option will require investors to dip into capital each year to equal the £5,500 income from the annuity, which will deplete the fund.”
First, Hymans examined a very low-risk investment strategy with around 90pc in cautious assets such as cash and low-risk bonds and 10pc in higher-risk holdings such as shares.
This approach produced at best a lacklustre average annual return of 1.5pc, and at worst just 0.9pc a year.
When all went well, the money ran out after 20 years when the pensioner was 85. At worst, the pot emptied after 19 years, at 84. Yet six out of 10 men are still alive in their mid-80s, with years of their retirement left to run, according to Hymans, which used longevity data from ClubVita, a specialist in the field.
Many pensioners opt for a “mixed-asset” investment approach, where half of their money is in safe investments and the other half in the stock market. Where this works well for the investor, even allowing for the spills and thrills of stock markets and interest rates, the average annual growth will be 3.6pc, according to Hymans. But even in this case, the money runs out after 25 years, when the individual reaches 90.
This may sound encouraging. But of men who invest at 65, some 39pc will still be alive at 90. Mr Noon said: “People are underestimating by miles how long they may live.”
However, if the market crashes early in retirement, damage will be inflicted on your fund from which it will struggle to recover. In this event the annual return might be only 0.5pc and the cash could run out after just 17 years, at 82. Seven out of 10 men are now expected to reach this not-so-grand old age.
Mr McPhail said: “We advise drawdown investors to use other sources of income in serious market downturns. The worst thing people
Annuity sales have plunged by 90pc as people adopt the pension freedoms. But new research reveals the risks they are taking, says Teresa Hunter ‘We encourage clients to guarantee they can cover basic outgoings via an annuity’ ‘People are underestimating by miles how long they may live’
can do is continue to take money out of their investments after a crash. They deplete their funds, and when the market recovers there is too little left to benefit from the upswing.”
This point is amplified by looking at the final example Hymans gave. Here, the saver adopts the highrisk strategy of putting 90pc of their retirement fund into the stock market in the hope of turbocharging the overall return, with just 10pc in lower-risk deposits and bonds.
If this strategy works well, it could pay off, producing an average annual return of 5.5pc. In this scenario, the money will last for 33 years until the pensioner is 98. But even then, some very elderly pensioners could be left facing penury: 7pc of 65-year-old men will reach 99, and 5pc will get a telegram from the Queen.
However, high-risk strategies can blow up in your face. If markets go against you the outcome could be disastrous. Here the annual return averaged over 35 years is a disturbing “zero” and the money runs out after 16 years – at 81, when seven in 10 men have years of retirement in front of them.
Mr Noon said: “Timing is everything. In this last example there were some great years for the stock market, but a crash early in retirement wiped out any prospect of significant growth in the saver’s overall pot later. There was too little left in the fund.”
Price of freedom? New research suggests thousands of people may end up having no money to live on in later life if they use the ‘pension freedoms’