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I really welcome this guide thatexplores the important issue of whatto do with your pension pot as you

approach retirement.All too often, people just assume theyhave to annuitise, and never engage withthe important alternative options availableto them. Once you have bought an annuity, youcan’t change it. You will never have a secondchance. It’s like putting all your eggs in onebasket, and it leaves you with no protectionagainst several serious risks that you arelikely to face during retirement. Number one is the risk of inflation. Mostpeople buy annuities that offer no protectionagainst rising prices. Even if inflationremains relatively low at around 2.5 per centa year, you will still lose a big proportion ofyour real income over 20 years. Second is the risk of dying soon. You cantake a ten-year guarantee, but even if youdie within the guarantee period the providerwill still keep around half your money. An annuity gives you no defence againstfailing health. Illness will get you anenhanced annuity rate, but if you buy theannuity and then become seriously ill, youcan’t change it.

Rate expectationsBuying an annuity today offers no protec-tion against the likelihood of interest raterises in the future. You are locking intorates that have been artificially held at his-toric lows by government policy. Investing in the stock market might helpprotect against inflation, but if you havebought an annuity your fund will notbenefit from equity returns. Using incomedrawdown, you will have the opportunityto benefit from rising markets and some

inflation protection, while retaining theoption of buying an annuity when interestrates return to higher levels.The final risk that an annuity does notprotect you from is the possibility that youwill need expensive care in later life. If youare in drawdown, you may still have somemoney left for this.

Sense and centenariansThe one major risk that an annuity doeshelp you with, and drawdown may not, isthe risk of living a lot longer than youexpected. Currently annuities are calculatedto assume an average life expectancy ofnearly 90. Most people will not live thatlong. If you live to 100, an annuity may bebetter value: but you have to bear in mindthat the real value of a standard annuity willhave dwindled considerably by that time. Think very carefully before you commityour entire pension fund to one product atone point in time with no opportunity tochange it. If you can afford to wait, take thetax-free cash and then consider whetheryou might want to wait for the market toimprove. And if you have to annuitise,consider just annuitising some, or phasing(see page 14). Leave yourself the option ofdoing better for yourself later. Finally, don’t forget about fees and charges(see pages 20-21). Annuities aren’t free: feesare typically 1.5 to 4 per cent of your fund.But be careful of all the fees and charges ondrawdown – for advice, administration andinvestment management.I wish you the best of luck with planningyour retirement finances. ◆

Ros Altmann is a leading pensions expert andformer government policy adviser on pensions,annuities and retirement.

Foreword

‘Once you have

bought an

annuity, you

can’t change it.

You will never

have a second

chance’

Foreword

3THE WHAT INVESTMENT GUIDE TO INCOME DRAWDOWN – www.WhatInvestment.co.uk

There are some excellent reasons to consider incomedrawdown over an annuity, argues Ros Altmann


The big decisionHow to choose between buying an annuity and entering drawdown

3 ForewordThere are some excellentreasons to consider incomedrawdown over an annuity,argues Ros Altmann

8

Drawdown lowdownAll the key points from the guide summed up in a single page

7

Take my adviceGetting value for money from your financial adviser

11

How it all worksA step-by-step guide to the different types of drawdown

13

Payback timeHow much you can and should withdraw from your pension fund

15

Bonds and beyondEssential ingredients for the perfect drawdown fund

17

Getting what you paid forHints and tips for minimising drawdown fees and charges

20

JargonbusterAll the essential terms defined in plain English

22

Contents

Editor Nick Britton 020 7250 7035 Staff Writer David Thorpe 0207250 7026 Senior Designer John Howe Group Sub-Editor Alan DobieSales Manager Gordon Sockett 020 7250 7033 Marketing ManagerSamantha Coles Subscriptions Helena Smith 020 7250 7055

What Investment is published by Vitesse Media Plc, Octavia House, 50Banner Street, London EC1Y 8ST, Tel: 020 7250 7010. An annual subscriptionto What Investment costs £35.95 for 12 copies (UK) or £107 (rest of theworld). Claims for non-delivery must be made within 14 days.

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ADVICE TO READERS:Information carried in What Investment is checked for accuracy, but we recommend that you make enquiries and, if necessary, take le gal advice before entering into any transactions.

ISSN 0263 953X. © Vitesse Media Plc. All rights reserved in respect ofall articles, drawings, photographs, etc published in What Investmentanywhere in the world. Reproduction or imitations of these areexpressly forbidden without permission of the publishers.

Columns

5 IntroductionIt’s high time we started toeducate ourselves about ourretirement choices, saysNick Britton

19 CommentConventional strategies fordrawdown investing aren’t fit for purpose, reckons Peter Doherty

Contents



It’s probably the single mostimportant financial decision you willmake in your life, and yet it’s one

that most people take without reallythinking about it.The choice between buying an annuity

or going into income drawdown – orindeed pursuing a third course – is onefaced by an increasing number of fifty- orsixty-somethings without a pensionscheme that pays them defined benefits.And yet, too many people do not evenknow about drawdown, and simply takethe first annuity on offer, costingthemselves thousands of pounds in lostincome over the remainder of their lives.At What Investment, we exist to help

people make investment decisions forthemselves. We believe that once you arearmed with the proper information, youare always going to be the best judge ofwhat to do with your money.

Going it aloneHowever, this is one decision that can be scary for a lot of people. It’s not likechoosing a fund or investment trust to buy, or deciding how to split your moneybetween shares, bonds and cash. Thosedeliberations are important, but they don’thave the same life-changing weight andirreversibility that surrounds the annuities-drawdown dilemma.That’s why it’s perfectly understandable

and sensible for people to take professionaladvice on this one. But if this question is tooimportant to be settled without advice, it’salso too important to be shoehorned into anhour or two with a financial adviser whodoesn’t specialise in pensions and who hassix other clients to see that day.To get the most out of any advice you do

pay for, it’s important that you start offwith as good an understanding as possibleof your various options and their potentialramifications.

This guideTo produce this guide, we’ve interviewedsome of the most respected experts in thepensions business and asked them for no-nonsense views about how pension investorscan get the best value for their money. The first article in the guide sheds light

on the choice between annuities, incomedrawdown, and the other options that areavailable to you. We then look at the role ofadvisers in helping you with these decisions. Next, we get down to the nitty-gritty of

how drawdown actually works: thedifference between capped, phased andflexible drawdown, and the tax implications. The following articles explore how much

you should be taking out of your drawdownfund and what you should be investing itin. Our experts suggest a number ofpossible strategies for securing an income,minimising losses, and beating inflation. Finally, we look at the different levels of

fees and charges associated withdrawdown. It’s not the most entertainingtopic, but it is essential to make sureyou’re getting value for your money. We live in an age when we can expect

not only to live longer, but to enjoy agreater variety of activities than wouldhave been conceivable a few generationsago. Along with advances in medicinethat have led to better physical health,reclaiming control of our finances fromintermediaries is the key to a morefulfilling and confident future.

Nick Britton is editor of What Investment.

Introduction

‘This isn’t like

choosing a

fund – it’s a

life-changing

decision that can

be scary for a lot

of people’

Introduction


It’s high time we started to educate ourselves aboutour retirement choices, reckons Nick Britton


*�Adviser�charges�can�be�up�to�3%�initial�and�1%�p.a.,�admin�and�platform�costs�can�be�up�to�0.75%�p.a.�TRACC�SIPP�providers�typically�cost�0.25%�p.a.�depending�on�SIPP�size.�On�a�£500,000�account�savings�over�10�years�would�be�approximately�£50,000�versus�a�typical�adviser�service.�Tideway�Investment�Partners�LLP,�83�Victoria�Street,�London�SW1H�0HW�are�authorised�and�regulated�by�the�Financial��Conduct�Authority.

Get�Your�Pension�Funds�on TRACC

Tideway�are�specialist�pension�advisers�and�investment�managers.�The�Tideway�Retirement�Account�(TRACC)�service�combines:

� �Specialist�pension�advice�for�just�0.35%�p.a.�with�no��up-front�charge.

� �A�secure,�managed�portfolio�designed�specifically�for�drawdown,�combined�with��a�self-select�option.�

� �Low�cost�administration��from�leading�SIPP�providers.�

� Adviser�Charges�and�Admin�Fees�For�a�£500,000�� Income�Drawdown�Account

� Typical�Adviser*� TRACC� SAVING

Year�1�� £17,000� £3,500� £13,500

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How�much�do�you�pay�for�advice�and�to�run�your�pension�accounts?

1

2

3

www.ontracc.co.uk

There are two ways to remove income from your pension: buying an annuity, and entering drawdown (see pages 8-10).

Annuities pay you a fixed amount however long you live. The payments areguaranteed but their purchasing power will decrease in line with inflation.

Drawdown is more flexible than buying an annuity and gives you the option of leaving in your will any money that is left over in your pension. However, itcarries risks and can be expensive.

The key risks of drawdown are not getting the investment returns, after fees, that you need to sustain your income, and living much longer than average(see page 15).

Now should be a good time to opt for drawdown as annuity rates remain verylow and are likely to rise in future. If you opt for drawdown, you can buy anannuity later (but if you buy an annuity, the decision is irreversible).

You can do drawdown yourself without advice which will lower your costs, butyou must make sure you understand and take advantage of the rules, andcontrol the key risks.

A good adviser should be able to help you pay less in tax and fees, and assistyou in investing sensibly. However, you need to make sure the adviser isunbiased and has specialist pension knowledge (see page 11).

Adviser charges and admin fees eat into your income payments so you need tomake sure they are affordable (see pages 20-21).

Managing your investment risks is a critical issue. Too much risk and you mightsee your income drop and take years to recover. Too little risk and you may notgenerate enough returns to sustain your income in the long run and you wouldhave been better buying an annuity (see pages 17-18).

Stocks and shares can bring higher returns but also come with risk, while bondsgenerate more predictable returns. Getting the right mix is key to controllinginvestment risk.

Drawdownlowdown

‘Drawdown is

more flexible

than buying

an annuity.

However, it

carries risks and

can be expensive’

1

2

3

4

5

6

7

8

9

10

Overview


Income drawdown explained in ten simple steps


Annuities versus drawdown

8THE WHAT iNvESTmENT GUiDE To iNComE DRAWDoWN – www.Whatinvestment.co.uk

L et’s start with a couple of simplenumbers. Five years ago, a 60-year-old man could use a

pension pot of £100,000 to buy an annuitythat guaranteed him £7,013 a year for therest of his life.

Today, the same man with the samepension pot could only get £5,317 a year.

The difference is stark. ‘Choosing incomedrawdown over an annuity has not been agreat trade for the past 20 years,’ says JamesBaxter, managing partner at Tidewayinvestment partners. ‘Now, it’s one of thebest trades you can make in your life.’

Ros Altmann, the former director generalof Saga, agrees that annuities have becomethe ugly sister of the pensions world. Shepoints out that the Bank of England hasbeen artificially pushing down the yields ongovernment bonds (gilts) by creating billionsof pounds of new money, all part of their bidto boost the economy. ‘The fact that annuityrates are tied to gilt yields should lead us toquestion the value of buying an annuityright now,’ she argues.

Although it is undeniable that gilt yieldsand annuity rates have been falling forseveral years (see line chart on page 9)annuities do offer one obvious advantage –the cast-iron guarantee of that fixed level ofincome. The problem is, you don’t knowwhat the real value of that money will be infive or ten years’ time, let alone 20 or 30.That depends, of course, on inflation.

The bar chart (page 9, top right) indicateshow an annuity bought at the age of 60could decrease in its purchasing power withtime. in 20 years, for example, it is possiblethat this £10,000 annuity would only be ableto purchase goods and services to the valueof £5,667 in today’s money.

You can buy an inflation-linked annuity,but the initial payout is likely to be abouthalf what you would otherwise get. At the

time of writing, thebest availableinflation-linkedannuity for a manor woman aged 60was paying £2,898, just54 per cent of aconventional annuity. Thisgives you less money to spendin the years when you mightbe best able to enjoy it.

Steve Jackson, an executive director atCoutts, says that for the private bank’sclients, going into income drawdown is a‘no-brainer’ when compared to the poorvalue offered by annuities. ‘our clients can

afford to take the risks drawdown entails,and they often don’t like handing controlover to other people – that isn’t somethingthat resonates with them,’ he remarks.

Drawdown allows you to leaveyour pension invested in the

market while taking anincome from it. Theflexibility and controlit offers are its keyattractions. However,the government does

place a few limits onwhat you can and can’t do.

Unless you can demonstratethat you have a guaranteed income

of £20,000 a year for the rest of your life,you cannot withdraw more than 120 percent of what is known as the ‘basis amount’, set by the Government Actuary’sDepartment (GAD). in practice, the basisamount is about the same as what youwould get from a standard annuity (formore details, see pages 13-14).

if you see terms you don’t understand,please refer to our Jargonbuster onpages 22-23.

Confused?

The big decisionHow to choose between buying an annuity and entering drawdown

Drawdown puts you in

control of your pension pot

and can offer better

benefits than an annuity

Top Tip



one big benefit of drawdown is that thedrawdown fund can be passed on when youdie, subject to a tax of 55 per cent. With anannuity, there’s nothing to leave in your will.

Drawdown is, of course, more complicatedthan buying an annuity, and fees and chargesfor advice, administration andinvestment management canquickly add up. Thismeans that in practice,drawdown may only besuitable for those witha larger pension pot.martin Tilley, directorof technical services atSipp provider Dentons,says that none of Dentons’clients have less than £50,000‘because it would be uneconomicto run the vehicle’. He adds, ‘We generallyrecommend that you need £100,000 tomake drawdown viable and take advantageof the flexibility.’

Jackson at Coutts says that it may beworth entering drawdown with £50,000 ‘if

you have other assets’ and aren’t heavilyrelying on the income from drawdown.However, Danny Cox, head of financialplanning at Hargreaves Lansdown, has adifferent take on it. ‘A lot of people say you need at least £100,000 to £250,000 for

a drawdown plan. That’s true under certain

circumstances – if youare paying a fixedfee, for example.But for me,drawdown is

suitable for peoplewho can accept some

risk with their income,and if their income needs are

met by a state pension or final salaryscheme, they might be able to afford to takea risk even with £5,000 or £10,000.’ He addsthat Hargreaves Lansdown allows people toset up drawdown with only £3,600.

Whereas annuities expose you to the riskof inflation, the risks of drawdown are morecomplex and potentially more frightening.

The biggest risk, of course, is that you will run out of money before you die. Thegovernment tries to control that by limitinghow much you withdraw, but there’s still the chance that your investments will bomb(see pages 17-18 for suitable investmentstrategies in drawdown).

According to Jackson, ‘if you are heavilyreliant on your pension, the drawdownroute can feel very uncomfortable purelybecause of investment risks. The risks ofdisinvesting [cashing in your investments]during a market downturn are incrediblyimportant, because you get the doublewhammy of declining asset values andneeding to draw income.’ in other words, as your portfolio shrinks, it produces lessnatural income, which means you have toerode the capital even more to meet yourneeds in a vicious circle.

Jackson adds, ‘if you go down the incomedrawdown route, you have to be prepared toaccept the fact that tactically you may have

0

2

4

6

8

10

12

14

16Annuity rates versus gilt yields, 1991 to present

Jan 91

60 (n

ow) 65 70 80 90

Aug 91

mar

92oct

92m

ay 93

Dec 93

Jul 94

Feb 9

5Se

pt 95

Apr 96

Nov 96

Jun 97

Jan 98

Aug 98

mar

99oct

99m

ay 00

Dec 00

Jul 01

Feb 0

2Se

pt 02

Nov 03

Jan 05

mar

06

may

07

Jul 08

Sept

09

Nov 10

Jan 12

mar

13

Apr 03

Jun 04

Aug 05

oct 06

Dec 07

Feb 0

9

Apr 10

Jun 11

Aug 12

Annuity rate %

15-year gilt yield %

Based on single life (male pre 01/2013)age 65, £10,000 pp

Source: The Annuity Bureau

0

2,000

4,000

6,000

8,000

10,000

Purc

has

ing

po

wer

in

to

day

's m

on

ey (

£)

Real value of an £10,000 annuitybought at age 60

What the table shows: how the purchasing power ofan annuity bought at the age of 60 could decreasewith time, assuming the consumer price index (CPI)measure of inflation remains at 2.8 per cent. Amountsof money are shown in today's values.

Source: What Investment

Your income in drawdown

will depend on investment

performance and is

not guaranteed

Top Tip




to cut back your income at some point. it isthe one facility you have to protect yourself.’

on the flip side, says Tilley, drawdown canbe useful for those who still have incomefrom other sources, especially if that incomeis lumpy. ‘For many of our clients, theirincome is quite variable. Some are inemployment and have income coming in,others have income from residentialproperties. income drawdown is flexible on ayear-by-year basis.’

Not either-orThe choice between annuities anddrawdown is not quite as stark as it seems.For one thing, you can opt out of thedecision altogether and leave your pensionfund untouched. This is by far the bestoption if you don’t need any income from it,as it gives you complete flexibility and untilyou’re 75, leaves it free from death duties upto the lifetime allowance of £1.5 million.

The decision to enter drawdown isn’t

irreversible. You can buyan annuity later, andsome argue that youshould positivelyplan to do this.‘When drawdownwas introduced, youstill had to buy anannuity at the age of 75,’Tilley explains. ‘it wasintroduced so that you couldmanage your pension optimally until suchtime as an annuity should be bought.’

Henry Tapper, a director at FirstActuarial, agrees. ‘What drawdown issupposed to do is not indefinite. it is abridge between when you start to drawyour retirement income and the point atwhich you annuitise, roughly between theages of 65 and 80. Annuities work at theback end as a way of insuring against therisk of living a long time.’

Tilley suggests that you should regularly

consider, as frequentlyas every year, whetherthe time has comewhen you would bebetter off buying an

annuity as opposed tostaying in drawdown.

Another halfway-housethat could be useful to some

is to use some of your pension pot tobuy an annuity, and move some intodrawdown. Jackson suggests that you mightconsider using your tax-free lump sum tobuy a certain level of guaranteed income inthe form of a purchased life annuity.

Opting outif all the rules and regulations surroundingpensions seem too complicated, you mightbe tempted to drop out of the systemaltogether and just invest your pensionsavings in iSAs. Gina miller, a foundingpartner at wealth management firm SCmprivate, explains the appeal. ‘The mainreason for preferring an iSA is simplicity.You put your savings in after you’ve paid taxon them, and once they’re in the wrapper,they’re safe. You don’t have any furtherpaperwork or dealings with the taxman.

‘You can then withdraw the capital gainsor income from an iSA at any time withoutpaying further taxes, and unlike an annuity ifyou die it can pass to your spouse.’

Under current rules, no-one can stop youtaking as much money as you like out ofiSAs: you don’t even have to tell the taxmanabout them. However, unlike pensions, thereare no contributions from employers or thegovernment to match yours. perhaps they’rebest seen as a useful supplement to a pensionwhich can allow wealthier savers to stashaway more while staying within the lifetimeallowance for your pension pot – which fallsto £1.25 million from April 2014. ◆

Annuities DrawdownYou receive a fixed, You leave your money

guaranteed income for life invested and draw what you need

In a nutshell

pros l income is guaranteed for lifel Simple and easy to understandl Can protect you against the risk of living

a long timel may be better for those with health

problems, as rates will be higher

l Can protect you against inflation if your investments perform well

l Balance of your drawdown fund can be left in your will (after 55% tax)

l The decision is reversible: you can choose to buy an annuity later

l You choose how much income you draw (subject to set maximum)

l Typically do not protect against inflationl Leave you no money to pass to your heirsl The decision to annuitise is irreversiblel Annuity rates are near historic lowsl offer no flexibility if your circumstances

change

l Level of income is not guaranteed anddepends on investment performance

l Harder to understand than annuitiesl may not be cost-efficient for smaller potsl income you draw is capped unless you have

£20,000 guaranteed income

it may help to think of

drawdown as a bridge

between starting to draw

retirement income and

buying an annuity

Top Tip


Cons


Using an adviser


There’s no obligation to takeadvice when entering drawdown.However, a good adviser can

help you assess whether drawdown is rightfor you, as well as guiding you on whichprovider to use, how much to withdraw,and how to invest the fund. ‘Deciding not to buy an annuity can be

the easy bit,’ says James Baxter of Tideway.‘A good adviser should be able to addconsiderable value by helping loweradministration costs, optimise tax andensuring sensible investments.’Many of the decisions around drawdown

are not one-off choices but requireregular review. Baxter adds,‘There are generally ways wecan help clients optimisewithdrawals to save taxwhich they won’t havethought of themselvesand these savings caneasily be more than ourannual advice charge.’

Knowledge is powerMartin Tilley of Dentons says thatthe vast majority of people facing thedecision about going into drawdown opt to‘get help’. ‘It is always worthwhile gettingadvice, at least at the outset if nothing else,’he says. ‘Some advisers will offer this on anhourly time-costed basis, and couple ofhours’ time is money well spent for adecision of that magnitude.’ Tilley acknowledges that some SIPP

providers will offer ‘illustrations’ for free.Illustrations are the basic information thattells you how much income you’ll be able todraw each year and how long your moneywill last based on various assumptions. ‘Sofor example, the illustration might say, “ifyou continue to draw x level of income andthe fund gets 4 to 8 per cent yield, this is

how it will panout,”’ Tilley

explains. ‘This iscrucial information,

but it does not meanthat 4 per cent is the

minimum or 8 per cent is the maximumyou will get.’ Danny Cox of Hargreaves Lansdown

takes a slightly different view. ‘I wouldn’tsay that everyone should take advice, but Ican understand why lots of people do.What we try and do is give people as muchinformation as possible so they can get tothe point where they can decide if theyneed advice or not.’ Cox adds that it maynot be worth taking advice unless you havea fund of at least £100,000, as the fees willmake too big a dent in a pension pot ofthat size (see pages 20-21 for more on fees).

Who to trustIf you do pay for advice, it’s essential tomake sure you’re getting value for money.For a start, make sure your adviser has a

specialist qualification in pension advice,such as the Chartered Insurance Instituteadvanced pension modules J04, J05 andAF3 (formerly G60). Don’t be afraid to askfor a referral to someone who does havethese qualifications. This is no different togoing to your GP for a check-up and thengetting a referral to a consultant.Baxter offers two warnings to those

seeking advice on drawdown. First, bewareadvice that might not be in your bestinterests. ‘Some advisers simply won’tadvise on drawdown as it’s perceived to betoo complex. This will lead them to steeryou towards an annuity simply so they cankeep you as a client and earn a fee.’Second, watch out for high upfront

charges. Baxter says that a 3 per cent initialcommission for setting up a drawdownaccount was ‘common practice’ until suchkickbacks were banned by the governmentthis year. However, he claims many advisersare still trying to collect upfront feesaround this level, which can be ‘completelydisproportionate to the work involved’. ◆

Take my adviceGetting value for money from your financial adviser

Even if you’re happy

managing your own

investments, it may be worth

getting some advice when

entering drawdown

TOP TIP


Find out why we were voted best comprehensive SIPP provider this year. Speak to your financial adviser today.

Investments can fall as well as rise and returns are not guaranteed. Your money is tied up until you take your benefits, which is normally from age 55 upwards. Applications must be from a financial adviser authorised by the Financial Conduct Authority. Suffolk Life does not provide financial nor investment advice.

Suffolk Life Pensions Limited is authorised and regulated by the Financial Conduct Authority (number 116298) and is registered in England and Wales (number 1180742). Registered office: 153 Princes Street, Ipswich, Suffolk, IP1 1QJ, United Kingdom. Tel: 0870 414 7000 Fax: 0870 414 8000. We may record and monitor calls. Call charges will vary. Q0042749 H0143490 September 2013

Drawdown rules and regulations

13THE WHAT InvESTMEnT GUIDE TO InCOME DRAWDOWn – www.WhatInvestment.co.uk

Drawdown is not a financialproduct – more a set of rulesgoverning how much you can

withdraw from your pension pot and when.It might help to imagine drawdown as a

wrapper. You can shift as much of yourpension as you like into that wrapper, stillinvested in bonds, shares or whatever. Oncein, it cannot be moved back again, thoughit can be used to buy an annuity later. Youcannot withdraw money from your pensiondirectly – drawdown, or buying an annuity,are the only two ways to get an income out.

Money in drawdown is governed by a fewcrucial rules. Most important are the rulesabout how much you can withdraw. Thisamount is determined by the GovernmentActuary’s Department (GAD) and isdependent on your age and the yield on a

15-year government bond at the time youenter drawdown (see box below). It has tobe reviewed every three years by yourpension provider.

Also important is what happens when

you die. Money in drawdown is subject to55 per cent tax before being passed on toyour heirs. In contrast, untouched money ina pension will not attract death duties untilyou reach the age of 75 (when it too is

How it all worksThe mechanics of drawdown explained

George wants to put £100,000 of hispension pot into a drawdown pensionfrom his 60th birthday, using the rest tobuy an annuity. The yield on 15-year giltsis 3.13 per cent on that day. This isrounded down to the nearest 0.25 per cent,giving 3 per cent. Using HMRC’sdrawdown pension tables, George worksout that the basis amount per £1,000 of his

pension is £53. So his £100,000 gives hima basis amount of £5,300. Each year, hemay take up to 120 per cent of thisamount, so his maximum annual incomefrom the drawdown pension is £6,360.

George’s combined income, from theannuity, drawdown pension and any othersources will be subject to income tax abovehis personal allowance of £9,440.

How much income can I take?


subject to 55 per cent tax onyour death).

In detailThere are three typesof drawdown:capped, phased andflexible. Both cappedand phased drawdownimpose limits on how muchyou can take out, as describedabove. They differ only in howyou move your pension over tothe schemes: all at once, in the case ofcapped drawdown; and in tranches, forphased drawdown (see box).

Flexible drawdown is only available tothose with a guaranteed income of £20,000

a year from other sources.Income from your

investments, or renton properties youown, does not countas guaranteed,

though state pensiondoes count. Those

fortunate enough toqualify for flexible drawdown

can take as much as they like fromtheir pension fund, with no restrictions.

Taxing the brainThe main reason to phase drawdown is tax. Steve Jackson of Coutts explains, ‘Sayyou have a £1 million fund. You can draw25 per cent as a tax-free lump sum so

that’s £250,000. If you draw it upfront,then £750,000 goes into drawdown and issubject to a 55 per cent tax charge onyour death.

‘But maybe you only need £25,000 a yearfor the next ten years. In year one, you draw

£25,000 tax-free, and put£75,000 of the rest

of the fund intodrawdown. Thatleaves you£900,000outside

drawdown thatyou can pass on

– in the event of yourdeath before 75 – without

any tax implications at all.’In this example, assuming your only

income is from your pension, you can avoidpaying any income tax for ten years.

Danny Cox from Hargreaves Lansdownsays it is ‘quite common’ for those under 75to defer entering drawdown for as long aspossible, especially if there is a chance theymay die before that age. He elaborates, ‘Atthe age of 65, if you are in ill health, youmight decide not to take the benefits ofyour pension fund and get by on otherincome so your heirs can get 100 per centof the benefit should you die before 75.’

However, if you do enter drawdown, it’srecommended that you spend or give awayany money you take out. Save it, and yourisk it being taxed twice: once when youtake the income, and again when you die inthe form of 40 per cent inheritance tax.Jackson calculates that this adds up to 64per cent for a higher-rate taxpayer.

Giving money away can be a good optionif you want to pass it on and you don’texpect to die for at least seven years: suchgifts are not regarded as part of your estatefor inheritance tax purposes. ◆

14THE WHAT InvESTMEnT GUIDE TO InCOME DRAWDOWn – www.WhatInvestment.co.uk

Capped drawdown The most common kind of drawdown,whereby you can withdraw a set amountfrom your drawdown fund each yeardependent on the GAD rates (available atwww.hmrc.gov.uk/pensionschemes/gad-tables.htm). The amount you are allowedto withdraw will be reviewed every threeyears by your pension provider and thebasis amount will be adjusted. A retireecan move any amount of her pensionfund into capped drawdown.

Phased drawdownphased drawdown is governed by thesame rules as capped drawdown and isdifferent only in that a retiree moves hispension pot over to the fund in tranches.Tax-free lump sums can be taken witheach tranche of money moved intodrawdown, equivalent to 25 per cent of

the money that is being removed fromthe pension fund on that occasion. Forexample, if you have £1,000,000 in yourpension fund, you could withdraw itin five tranches of £200,000,each time putting £150,000into drawdown and taking£50,000 tax-free.

Flexible drawdownFlexible drawdown is notsubject to the maximumincome rules applied tocapped and phased drawdown,but is only open to those who canprove that they have a guaranteedannual income of at least £20,000 forthe rest of their life. This could be froma state pension, workplace pensionscheme, an annuity, or any combinationof these.

Types of drawdown

Saving income from drawdown

is not recommended – it’s better

to spend it or give it away to

avoid inheritance tax

TOp TIp

phasing drawdown can be

advantageous if you take a tax-

free lump sum each time you

move money into your

drawdown fund

TOp TIp

www.hmrc.gov.uk/pensionschemes/gad-tables.htm

www.hmrc.gov.uk/pensionschemes/gad-tables.htm


You’ve been saving into yourpension for years, forgoing thatholiday or new car in return for

the peace of mind that comes from theexpectation of a well-heeled retirement.Now your drawdown plan is going to

give you the chance to finally get somemoney out. And one of the importantbenefits of drawdown is that you get todecide how much, within certain limits.

Following GADThere are a number of different ways toapproach the question of how much youshould be drawing. The simplest one is justto take 100 per cent of the basis amountspecified in the GAD tables (see previousarticle). You can take up to 120 per cent,but Danny Cox of Hargreaves Lansdownworries that ‘this is not sustainable, unlessyou get lucky’. Instead of basing your withdrawals on

the government limits, Cox suggests thatyou stick within the natural yield of yourportfolio. ‘If you manage it correctly, thenatural yield of your assets in drawdowngives you a pot of cash that is used to paythe income. Ideally, you’re not biting intoyour capital.’He adds that the natural yield of a

drawdown portfolio might be 3.5 to 4 percent, not so different to what an inflation-linked annuity might offer (3.2 per cent).Over time, however, the drawdownportfolio should outrun the annuity if thecapital value of the assets increases fasterthan inflation.But Nick Gait, an adviser at Tideway

Investment Partners feels that it might notbe realistic for many investors to use thenatural yield alone, particularly wheninterest rates are so low. ‘The hard reality is that most investors

will be underfunded when they hitretirement and are going to need morethan just their pension funds to generatetheir retirement income. Many will have

to rely on releasing equity from theirproperties.‘So investors may need to accept that

they will eat into pension capital withhigher withdrawals in early years and thensupplement it with other investmentincome later on.’An alternative approach to drawing the

natural yield is to look at what’s called the ‘critical yield’, or the total investmentreturn you’ll need after all costs to sustainwithdrawals over your estimated lifeexpectancy. This is one of the keycalculations when judging whether it’s

better to go with drawdown or an annuity,and should be recalculated as time goes byand annuity rates change.

How much do you want?Martin Tilley of Dentons suggests startingoff with the income you want. Your advisercan then tell you how much yield youwould need to generate in order to achievethat income level, and you can ‘build aportfolio of investments around that’. Ofcourse, the higher the critical yield, themore risk you’ll have to take with yourinvestments to achieve it. If you’re notprepared to take that risk, says Tilley, anannuity might be more appropriate.Tilley agrees that the concept of natural

yield can be important, but maintains thattaking income above the natural yield maybe inevitable. ‘If the pension fund isyielding 6.5 per cent and you are taking 7 per cent, you probably shouldn’t worry.As you get older, the GAD rates increaseso less pension pot is required to pay thesame level of income. However, if you need6 per cent and the drawdown fund is onlygiving you 3 or 4 per cent, you run the riskof depleting your pot too rapidly.’ ◆

Withdrawing money


Be aware of how the income

you are taking compares with

your portfolio’s natural yield

TOP TIP

Payback timeHow much to take out, and when

Example critical yield calculation

What the table shows: a yield of 3.5% is needed tomatch the performance of an annuity for a 60-yearold who expects to live to 90. No allowance is madefor inflation. Source: What Investment

Pension pot £100,000

Age now 60

Life expectancy 90

Best annuity offers £5,425

Critical yield 3.5%


Source: FETrustnet 5th September 2013

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30%

25%

20%

15%

10%

5%

0%

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Note: Past performance is not a guarantee of future returns. The value of investments and the income they produce can go down as well as up. Tideway Investment Partners LLP, 83 Victoria Street, London SW1H 0HW are authorised and regulated by the Financial Conduct Authority.

123

11%

6%

25%

1 Year

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2 Years

7%

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Capital preservation Stable returns regardless of market gyrations Income generation

www.tidewayinvestment.co.uk

Investment strategies for drawdown


The previous articles in this guidehave looked mainly at thedrawdown wrapper. But for many

investors, the key question will be what youput in that wrapper.Your investment strategy for drawdownclearly needs to be different from how youwould save for retirement. Assets thatproduce an income will be important, andyou’ll want steady returns rather than lots ofvolatility. On the other side of the coin, youmay need to take controlled risks in orderto achieve your critical yield (see previousarticle) or keep pace with inflation. Experts have differing views on what agood drawdown fund should contain. HenryTapper of First Actuarial suggests that yourstrategy should not be fixed but shouldchange between the ages of, say, 65 and 80,when you might consider buying an annuity.‘You would start off by investing prettyheavily in growth assets – equity funds, realassets such as property, and maybe a fewalternative investments, and stay almost 100 per cent in these for the first five years.From years six to 15, you would thengradually swap these assets for long-datedgilts and corporate bonds, assets that willproduce similar returns to an annuity.’Importantly, Tapper advocates doing theswapping according to a fixed schedule, say10 per cent of the fund per year, rather thantrying to time the markets. This ‘glide path’strategy is the way that institutions managepension funds.

A traditional recipeDanny Cox of Hargreaves Lansdownproposes that someone entering drawdownshould keep 10 per cent of their assets incash to pay the income over the first coupleof years, put 20 per cent in fixed incomefunds to generate yield, and allocate theremaining 70 per cent to equity income

funds. The funds he puts forward asexamples (see table, page 18) are all activelymanaged, which is where hediffers from Gina Miller ofSCM Private, who insiststhat the lower costs ofpassive funds makethem particularlysuitable for thedrawdown investor.It’s worth noting thatthere are passive fundsfocused on income, such asthe State Street UK DividendAristocrats ETF, which tracksthe UK’s top dividend paying companies.This fund, which has a total expense ratio of 0.3 per cent, has beaten most activelymanaged funds in the IMA Equity Incomesector since launch.Property is an asset class that can be usefulfor drawdown because its income is notcorrelated (linked) to that of equities orbonds. Actual bricks-and-mortar property

can be held in a SIPP (see pages 20-21),and is favoured by wealthier clients of firms

like Dentons and Suffolk Life.Tracyann Keen, a pensionsexpert at James Hay,says that propertyyields 6 or 7 per centon average andhouse prices ‘havetended to beatinflation, though there

is a risk of periodic pricecrashes’. Sales of second

properties held in a pension do notattract the usual capital gains tax.

Mixing it upSteve Jackson at Coutts makes one essentialpoint. ‘It is extremely dangerous to adopt anarrow investment approach. We wouldrecommend a very broadly diversifiedportfolio that covers all the main assetclasses, including those that can providenatural inflation-proofing over the long term

Above all else, your

drawdown fund needs

to provide a decent level

of stable income

TOP TIP

Bonds and beyondEssential ingredients for the perfect drawdown fund


such as equities, property and commodities.’He adds, ‘To make drawdown work, youneed a reasonable proportion of risk assets.If you keep everything in fixed income andcash, you will erode the purchasing power ofthe fund – frankly, you might have been justas well off buying an annuity.’

Eyes on the downsideControlling that risk, though, is paramount.Tideway’s James Baxter points out that theUK’s large company index the FTSE 100has fallen by 40 to 50 per cent on twooccasions in the past 15 years. The dotcomcrash and the credit crunch had a devastatingeffect on many people’s drawdown funds. Inhis view, allocating most of your portfolio tostocks and shares makes you too vulnerableto market shocks of this kind. ‘If you start off drawdown with your fundsbeing 20 per cent down, you will need along time to catch up. A 20 per cent lossrequires a 25 per cent recovery,’ says Baxter.One solution is to combine drawdown withan annuity that gives you the income ‘you

absolutely want to have’. However, for thosereliant on drawdown alone, he proposes amuch lower allocation to equities(around a third).In response to thesuggestion that equitiesare too risky to formthe lion’s share of adrawdown portfolio,Cox argues thatinvestors who restricttheir income to theportfolio’s natural yield (seepage 15) will be able to sit backand wait for a likely stockmarket recovery. ‘If you had stuck to thenatural yield of the portfolio throughout the2008 crash, your fund would have more thanrecovered by now, in all likelihood,’ he says.But Peter Doherty, chief investment officerat Tideway, has an altogether different wayto look at the question. He argues that,above all, drawdown investors need to‘match their liability stream’. In other words,because they know they will need a certain

level of income every year for the next 25 or30 years, they should buy assets that are

designed to provide that. Itfollows that ‘the neutral,or riskless position’ fora drawdowninvestor is to buy aportfolio of long-dated, investment-grade bonds. It’s stillpossible for a skilled

manager to do this, hebelieves, at rates similar to

what an annuity would offer, with thedifference that you still have your fullprincipal left at the end.Doherty acknowledges that the bondportfolio offers no inflation protection, so it is sensible to allocate some of yourdrawdown fund to equities. However, he is not a fan of an equity-centred approach.‘John Ralfe, who took over Boots’ pensionfund and derisked it last decade, said that ifyou are buying equities with your pensionyou are effectively borrowing money fromyour future to invest now – a bit likemortgaging your house and using theproceeds to play the stock market.’ As headof corporate finance at Boots, Ralfe moved100 per cent of the company’s pensionportfolio to AAA-rated, long-dated sterlingbonds – binning the cherished diversificationprinciple, but putting the fund on thesecurest possible footing. There is no one right way to invest fordrawdown. However, a common point ofagreement is the need to be careful over thelevel of equity exposure in your portfolio.Those happy to take a lower income canafford to invest more heavily in stocks ifthey wish, but those looking for higherwithdrawals and concerned not to see theirincome fluctuate will need to invest inassets with less downside risk. ◆



Equities and property can help

protect you against inflation,

but with added risk

TOP TIP

Example portfolio for drawdown

Fund CategoryArtemis Income Equity (UK)

First State Global Listed Infrastructure Equity (global)

Invesco Perpetual High Income Equity (UK)

JOHCM UK Equity Income Equity (UK)

Liontrust Macro Equity Income Equity (UK)

M&G Optimal Income Bonds (sterling)

Newton Global Higher Income Equity (global)

Royal London Sterling Extra Yield Bond Bonds (sterling)

Threadneedle UK Equity Alpha Equity (UK)

Cash -

What the table shows: An example drawdown portfolio of £100,000 with £10,000 in each holding. This is notintended as a recommendation. Source: Hargreaves Lansdown



The great attraction of going intoincome drawdown, or deferringyour purchase of an annuity, is

that these options can offer you hugeflexibility and the opportunity for a betterlifetime payout. however, there are twocommon mistakes that can lead to adisappointing outcome.

The first is paying too much in adviceand account fees. The higher these costsare, the greater the investment return youneed and the more risk you have to take togenerate the same net income.

The second big mistake is to opt forinappropriate investments and funds whichprovide little certainty of future returns andput your capital at too great a risk.

at Tideway, we both manage investmentsand advise people on their pensions. Thisgives us insight into pension rules,annuities, and the impact of interest ratesand investment market movement ondrawdown investors.

We’ve designed the Tideway retirement

account (Tracc) service to provideaffordable advice combined with a low-costsIPP. The Tracc portfolio is built toprovide secure, steady returns ahead ofinflation after allowing for all costs. Theemphasis is on capital protection and theneed to deliver returns year on year – in allconditions, and over the long term.

How we’re differentThe classic ‘balanced’ or ‘managed fund’approach to pension investing (see chart,below left) typically involves buying into arange of investments with little certainty asto what returns will be achieved – either inparticular investments or across theportfolio. under this approach, the investoris at the mercy of the markets. someinvestments will be doomed to earn lessthan the return required to beat an annuitypayout, diluting overall returns.

another problem with relying on returnsfrom broad equity and fixed income marketsis the danger of sustained capital losses, orlong periods of sub-target returns. suchupsets result in a drop in future incomewhen the drawdown account is reviewed.

By contrast, the Tracc portfolio (aboveright) employs three distinct investmentstrategies that each seek to deliver thereturns required, after costs, to outperformthe lifetime payout of an annuity. Together,they provide diversification, but we also useactive hedging strategies to reduce risk.

1. Individually selected corporate bondsThese are the default choice for drawdowninvestors, providing secure, predictablereturns. To optimise returns, Tideway seeksthe highest-paying securities from the safestcompanies. The risk of default is low andthe payout to maturity exceeds the targetreturn needed to match an annuity.

2. Target return strategiesThese combine fixed income and equityinvestments. hedging strategies are usedactively to protect capital and smoothreturns. such strategies can includeprotecting fixed income investments fromshort-term losses created by rising interestrates; reducing the volatility of equityinvestments; and exploiting, or protectingagainst, currency exchange rate movements.

3. EquitiesThe Tracc portfolio invests in equitiesas a long-term defence against inflation.however, the amount of pure equityexposure is limited so that short- tomedium-term losses don’t have too great animpact on the overall account value.

The Tracc portfolio can be used as atotal income drawdown investmentsolution, or as a core holding alongsideother ‘fit for purpose’ investments. ◆

Peter Doherty is partner and chief investmentoff icer at Tideway Investment Partners. For more information about TRACC, call0203 178 5982 or visit www.ontracc.co.uk.

The industry’s solution

The TRACC portfolio

EquitiesFixed income

Property

Hedge funds

Cash

Other

Private equity

Commodities Source: FT Wealth ManagementReview, June 2013

Equities Fixed income Target Return funds

19The WhaT InvesTmenT guIde To Income draWdoWn – www.WhatInvestment.co.uk

Investing for income drawdownConventional strategies for drawdown investingaren’t fit for purpose, argues Peter Doherty


www.ontracc.co.uk

Fees and costs


ust as drawdown is more complicatedthan buying an annuity, so are theassociated fees and charges.Annuities tend to build fees and

charges into the rate that you are offered.It’s worth knowing that whoever is sellingyou the annuity is taking a commission,typically between 1.5 and 4 per cent of yourpension pot. That tends to be reflected inlower payouts, rather than billed upfront.The broker Annuity Direct, for example,will receive a commission between 1.8 and 3 per cent, subject to a minimum of £300and a maximum of £3,000. You can choose,if you want, to pay this out of your ownpocket, which means you’ll get a slightlyhigher rate on your annuity. The differenceis marginal, though.In contrast, the costs of drawdown are splitinto three levels. There is the administrationfee for the pension wrapper (for example, aSIPP), the costs of investment management,and anything you pay for advice.

Wrapping it upThe costs of the wrapper depend onwhether you opt for an insurance product, a low-cost SIPP or what’s known as a ‘fullSIPP’. Low-cost SIPPs are offered by firmslike AJ Bell, Alliance Trust Savings,Bestinvest, Fidelity FundsNetwork andHargreaves Lansdown. According to SteveJackson of Coutts, fund platforms andinsurance companies may be prepared tocharge you next to nothing for admin costs,because they expect to make moneythrough investment management charges,commissions or platform fees.Hargreaves Lansdown charges no annualfee for its Vantage SIPP but does takecommissions from fund providers and leviesplatform costs (often 0.25 per cent) when

you hold certain investments, such as ETFsand investment trusts. It’s worth noting thatthe practice of taking commissions is aboutto be banned, so platform and SIPPproviders will have to be moretransparent about the costof their products. Anumber of low-costSIPP providersincluding AJ Belland Alliance TrustSavings have madethis move already,and have explicit admincharges. Alliance TrustSavings has a flat charge of£135 a year; it does, however,levy dealing fees for buying and sellingopen-ended funds, which Hargreavesdoesn’t. Fidelity charges up to 0.65 per cent,less for bigger pension pots. This includesplatform fees of 0.25 per cent.

Freedom of choiceFull SIPPs are a different breed and allowyou to hold anything which the law permits,including bricks-and-mortar property and

stakes in private companies.Because of this flexibility,they are pricier; SteveJackson at Coutts saysyou would expect topay £400 or £500 as aflat annual fee. SuffolkLife charges up to£505, Dentons £525, and

James Hay Partnership upto £330 plus platform charges

for funds held in its Investment Centre. Both low-cost and full SIPPs will chargeyou more when you are in drawdown, formanaging the income payments. SuffolkLife, for example, will bill you £155 extra ayear, James Hay £150, and Dentons £120.Hargreaves Lansdown makes no charges for

Getting what you paid forHow to minimise drawdown fees and charges

The best-value SIPP for

you will depend on how

much you invest, and

what you invest in

TOP TIP

J


regular payments but levies £12 when youchange your payment amount or £30 formaking one-off payments. You will alsoneed to pay your provider for your three-yearly GAD review to determine how muchyou are allowed to withdraw (see page 13).

Looking after your moneyFor most people, investment managementcharges will make up the bulk of the feesthey pay in drawdown. It’s also the areawhere you’ll get most benefit fromshopping around. For open-ended funds that are activelymanaged, annual charges are likely to be inthe region of 1 to 2.5 per cent a year; forinvestment trusts, they tend to be around

1 per cent; and for passive funds, whichsimply track an index, you would expect topay as little as 0.1 to 0.5 per cent. Thesecosts don’t include platform or broker fees,which may be charged when you buy or sellthe investment, or simply forholding it in a SIPP. Jackson says there isa ‘significant movetowards loweringcosts’ as a result ofrecent legislation.‘At most youshould pay 1.5 percent a year and ideallyyou are trying to get thatdown where you can, as longas it doesn’t prejudice theinvestment performance,’ he says.

Helping handYou may only take advice when enteringdrawdown, or seek regular annual advice.You’re not obliged to take any advice at all(see page 11 for a discussion of the reasonsyou might want to do so). Charges vary widely. ‘There are 1,000,001different structures,’ says Jackson. ‘Typicallyyou should be looking at 0.5 to 1 per centas a one-off charge [when enteringdrawdown], ideally closer to 0.5 per cent. Ifyou have a larger portfolio, it can be farbetter to negotiate a fixed fee rather thanpaying a percentage.’Danny Cox at Hargreaves Lansdown saysthat drawdown advice from the firm costsbetween 0.5 and 2 per cent, typically 1 percent, but there is no minimum charge. For subsequent reviews, the typical fee is0.5 per cent. At the other end of themarket, Dentons charges a one-off flat feeof £330 to value your fund and produce a

report telling you what your options are. You can of course expect to pay more ifan adviser is assessing your investmentportfolio, in addition to providing the basicillustrations of how much you can expect to

receive each year in drawdownand how that compares toan annuity.

A big biteJames Baxter ofTideway InvestmentPartners says that it’snot uncommon for all the

charges of drawdown to addup to more than 3 per cent a

year, including admin costs of 0.6 percent, adviser charges of 1 per cent andinvestment management charges of up to 2 per cent. Such lofty fees have a direct impact onpossible investment strategies. ‘If you arehaving to pay 1.6 per cent a year for adviceand admin, this can drop the 4 per centincome coming from your investments to2.4 per cent, lower than a typical index-linked annuity. This is why drawdown hasbeen criticised as too expensive.’ The message is clear: drawdown investorsneed to form a full picture of what they are paying and whether they could get itcheaper elsewhere. ‘You might need acritical yield of 5 per cent to meet yourincome requirements and be able to buy avery nice ten-year bond yielding 6.5 percent to maturity which could get this donewith very little risk,’ adds Baxter. ‘But if 3 per cent of this goes in fees you aresuddenly well below the yield you need.Higher fees mean you are forced to go forhigher risk investments where the returnsare much less certain.’ ◆

Fees and costs


Percentage fees work well

for smaller portfolios; if you

have a larger pot, negotiate

a fixed charge

TOP TIP

Typical annual costs of drawdown

Administration/SIPP wrapperAnnual fee (full SIPP) £400-£525

Annual fee (low-cost SIPP) Free-£225

Platform charges 0.25%

Charge for managing drawdown Free-£150

Investment managementOpen-ended funds 1-2.5%

Investment trusts 1%

Passive funds 0.1-0.5%

Specialist investments 2-4%

AdviceOne-off advice on entering drawdown 0.5-3%

Regular reviews in drawdown 0.5-1%

What the table shows: Typical ranges of feescharged by SIPP providers, investment managersand advisers to people in drawdown. All costs areannual except one-off advice on enteringdrawdown. Percentage charges are applied toyour capital. Source: What Investment


Jargonbuster


Adviser charge Before 2013 advisers could be paid by feesor commissions; now, by law, it must befees. These should be expressed to you inhard cash terms not just percentages andyou will have to sign to say you agree tothem being deducted from your account.

Annuity A financial product that typically pays youa set amount of money for the remainderof your life. Retirement annuities arebought with money in your pension pot,while purchased life annuities can bebought with cash.

BondsSee ‘Fixed income’.

Capped drawdownThe most common kind of drawdown,whereby you can withdraw a set amountfrom your drawdown fund each year basedon the GAD rates (see ‘GAD rates’).

Critical yieldThe amount of investment return afterfees, including income and gains, that youraccount will need to generate to meet yourincome withdrawals over time or to matchthe income payments of an annuity youcould buy with your fund. Not to beconfused with the natural yield on yourportfolio which is just the income collectedfrom your investments each year.

Defined contribution pension A defined contribution (DC) pensionscheme does not give you a guaranteed

payout in retirement, as opposed to a‘defined benefit’ (DB) scheme which, forexample, pays you two-thirds of your finalsalary increased in line with inflation.

Drawdown Not a financial product but an alternativeto buying an annuity, also known aspension drawdown or income drawdown.In drawdown, a retiree’s pension fundremains invested in the market and theydraw income from it as and whenrequired. Introduced in 1995, drawdowncan be accessed through an insurerdrawdown plan or a self-invested personalpension (see ‘SIPP’).

ETFShort for ‘exchange-traded fund’, ETFs aimto track an index such as the FTSE 100 forlow annual management charges.

EquitiesAlso known as stocks and shares, equitiesgive you a small stake in a company quotedon the stock market. You have the right toreceive any dividends and will benefit fromany rise in the share price (or suffer from afall). Most people invest in equitiesthrough funds rather than buyingindividual shares directly.

Fixed incomeA technical term for bonds. Bonds areessentially loans you make to a company orgovernment (the issuer), which pays youinterest (called a coupon). On maturity,your money (called the principal) is repaidin full, unless the issuer defaults on itsdebt. Bonds are rated according to their

perceived riskiness, with the best ratingbeing AAA. Bonds with a rating of at least BBB are referred to as ‘investment-grade’. Most people invest in bondsthrough funds rather than buyingindividual bonds directly.

Flexible drawdownFlexible drawdown is not subject to themaximum income rules applied to cappedand phased drawdown, but is only open tothose who can prove that they have aguaranteed annual income of at least£20,000 for the rest of their life. Thiscould be from a state pension, workplacepension scheme, an annuity, or anycombination of these.

GAD ratesTables published by the GovernmentActuarial Department (GAD) that specifyhow much money you are allowed towithdraw from your drawdown fund eachyear. The ‘basis amount’ you can draw isdetermined by your age and the yieldavailable on a 15-year gilt at the time (the higher both of these are, the moregenerous the basis amount). You maywithdraw up to 120 per cent of the basisamount each year. The basis amount isreviewed every three years by your pensionprovider. To see how GAD rates work inpractice, refer to the box on page 13.

Gilt yield Expressed as a percentage, the incomeavailable on a UK government bond (gilt).Annuity providers use gilts to providepensioners with steady income, so annuityrates are very closely related to the yield ona 15-year gilt.

Jargonbuster


Glide pathAn investment strategy that involves sellingrisky assets and buying safer ones as you getolder, according to a predetermined plan.

Hurdle rateIn the context of pensions, this tends torefer to the minimum rate of return yourdrawdown portfolio needs to produce inorder to do better than the annuity youcould have bought with your pension pot.

Income drawdownSee ‘Drawdown’.

Investment trustsFunds that are quoted on the stock marketand raise a limited amount of money toinvest according to a defined mandate. Forthis reason they are also known as ‘closed-ended funds’.

ISAIndividual savings account. Each year, thegovernment allows you to invest £11,520tax-free in a stocks and shares ISA.Alternatively, you can save up to £5,760 ina cash ISA and the balance of the £11,520in a stocks and shares ISA. You canwithdraw the money whenever you wantand are not taxed on withdrawals.

Lifetime allowanceThe maximum amount you can save inyour pension fund and still receive all thetax benefits associated with pensions. Thegovernment has cut this to £1.25 millionfor the tax year beginning 6 April 2014,from £1.5 million previously. There will

also be an annual limit of £40,000 on howmuch you can save in a pension from the2014/15 tax year, reduced from £50,000.

Long-dated bondsBonds that offer to pay your money back at a distant point in the future, forexample in 15 or 20 years’ time. Long-dated bonds are useful for pension investorsbecause they pay a stable, predictableincome for a long period. However, theyare vulnerable to inflation because the realvalue of the money returned to you inseveral years’ time is less than the moneyyou use to buy the bonds today.

Natural yieldThe amount of income that you can getfrom your drawdown portfolio withoutwithdrawing any of your capital. Thiscould come from dividends, income fromfunds, or interest paid on cash, forexample.

Open-ended fundsThe majority of funds marketed direct toUK investors are structured as open-endedfunds, which means they can expandindefinitely as they attract more money.

Phased drawdownPhased drawdown is governed by the samerules as capped drawdown and is differentonly in that a retiree moves his pensionpot over to the fund in tranches. Tax-freelump sums can be taken with each trancheof money moved into drawdown,equivalent to 25 per cent of the moneythat is being removed from the pensionfund on that occasion. For example, if you

have £1,000,000 in your pension fund, youcould withdraw it in five tranches of£200,000, each time putting £150,000 intodrawdown and taking £50,000 tax-free.

Real valueThe value of an asset after taking inflationinto account. For example, the real value of£10,000 left in a bank account that paid nointerest might be only £7,158 in ten years’time. This is a way of saying that althoughyour bank balance would still be £10,000 in2023, it would only stretch to buying goodsand services worth £7,158 today.

SIPPSelf-invested personal pension: a tax-efficient wrapper for your pension savingsand investments. You choose what to investin. Your contributions to a SIPP will beenhanced by tax relief from the government(up to certain limits – see ‘Lifetimeallowance’) but you’ll also be taxed on whatyou take out in retirement. No withdrawalscan be made before the age of 55.

Tax-free lump sumWhen buying an annuity or enteringdrawdown, a retiree is said to be‘crystallising’ his or her pension. At thispoint up to 25 per cent of the total pensionpot (or the amount being ‘crystallised’) canbe taken as a tax-free lump sum. Forexample, if you have £500,000 in yourpension pot and move £300,000 intodrawdown, you can take a tax-free lumpsum of up to £100,000, leaving theremaining £100,000 untouched in thepension. You can also move money intodrawdown in phases, taking a tax-free lumpsum each time (see ‘Phased drawdown’). ◆

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Your trusted SIPP partner. - Growth Business€¦ · to do with your pension pot as you approach retirement. All too often, people just assume they have to annuitise, and never engage