Advantages and Disadvantages of Drawdown Pensions (2024)

FAQs

Advantages and Disadvantages of Drawdown Pensions? ›

It also offers the potential for growth, although investment returns aren't guaranteed. The flexibility of drawdown can be an advantage, but it also comes with more risks. Your income isn't secure, and you could run out of money if your investments don't perform as well as you might have hoped.

And now they suggest that one common rule of thumb no longer works. The often cited 'safe' level of drawdown is 4 per cent. You can start by taking 4 per cent of your pot in the first year of retirement, and then increase the withdrawals by inflation each year thereafter.

Drawdowns present a risk to investors in terms of how much effort or changes in prices are required to overcome them or return to the initial peak. This is why investors watch drawdown keenly and change trading strategies when things threaten to get out of hand.

Can I still pay into pensions if I'm in drawdown? Yes, you can still make pension contributions. You'll still receive tax relief on personal contributions provided you're within your contribution limits and you're under 75.

Your pension helps you to maintain your standard of living in retirement, and savings provides important supplemental income for unforeseen expenses. Group pension plans provide guaranteed, monthly income for life, which makes financial security in retirement much more achievable for those who have them.

Less risky for the employee

The employee is also not required to contribute to the plan, meaning there is no cost to them. From the negative side, employees do not have any input on how the money is invested, leaving the potential for poor management, and the results are sometimes not adjusted for inflation.

What is the 70% rule for pension? ›

What is the 50 – 70 rule? The 50 – 70 rule is a quick estimate of how much you could spend during your retirement. It suggests that you should aim for an annual income that is between 50% and 70% of your working income.

For most people going into drawdown, a £1m pension pot will provide you with an income of £40,000+ per year, rising with inflation. This reflects a 4% withdrawal rate per year – explained more fully later on. However, it's not without risk. If you take out too much, too quickly – you risk running out of money too soon.

The '4% rule'

A popular 'rule of thumb' is that you can safely take an inflation-adjusted 4% from your pensions and investments each year (far lower than the 8% mentioned above) without running out of money. How might this rule apply to a typical retiree?

In financial terms, the "crisis" represents the gap between the amount of promised benefits and the resources set aside to pay for them. For example, many U.S. states have underfunded pensions, meaning the state has not contributed the amount estimated to be necessary to pay future obligations to retired workers.

Situation if a sponsoring employer goes bust

If you're in one of these workplace pensions and your employer goes bust, the pension you have built up will still be safe. This is because the pension assets are held in a separate trust overseen by a trustee company which looks after members' interests.

Pension risk refers to the possibility of losing money that has been invested in a pension plan. There is no guarantee that a particular investment strategy will meet investment objectives or provide a given level of income.

Drawdown is much more flexible than an annuity. You can change how much and when you take money out of it, and how any money you don't take out is invested. But you could run out of money because, unlike with an annuity, your payments are not guaranteed.

While it can be un-settling to witness a decline in the value of your pension, it's crucial to remember that these fluctuations are a normal part of investing. The recent global events and economic uncertainties have undoubtedly impacted pension funds, but history has shown that markets tend to recover over time.

A drawdown measures the historical risk of different investments, compares fund performance, or monitors personal trading performance. It is usually quoted as the percentage between the peak and the subsequent trough.