Drawdown: still a retirement solution for the rich

pension scheme concept with jar ...

Pensions freedom was supposed to herald a levelling of the playing field when it comes to accessing retirement cash.

Previously, only the wealthy could use pension drawdown (where the pension remains invested and an income or lump sums taken from the pot as needed) while those whose pensions were too small to use drawdown had to make do with an annuity.

By doing away with the 'minimum income requirement' on drawdown, politicians believed they were unshackling less wealthy pensioners from the tyranny of annuities and giving them the chance to become an investor in retirement.

While they may have succeeded in the first – no one has to buy an annuity now – have they really succeeded in the second?

Research by consumer group Which? Has shown that a £250,000 pension pot invested in a drawdown fund and 6% income taken a year could result in charges of up to £26,490 over a decade. Granted this is a worst case example but the best scenario sees a retiree paying out just over £16,000 in 10 years – not an inconsiderable sum.

What these figures say is that although everyone can now access drawdown, the cost of doing so may be too much to bear for some pension pots. Keep in mind that while a £250,000 pot may seem a lot in the example it would generate an income (if you bought an annuity) of around £12,500 a year.

Suitable for the wealthy?

The hefty cost of drawdown means that in many ways it is still only suitable for the wealthy. It also shows just how behind the insurance industry is when it comes to developing straightforward, easily-accessible and affordable retirement products for the mass market.

Don't get me wrong, it's not the entire financial services sector that is woefully behind. There have already been some interesting flat-rate drawdown launches from companies trying to fill the gap that pension freedom has opened up.

Unfortunately, part of me wonders whether retirees who do opt for drawdown are ready not just for the cost of the product but also the cost of advice they will inevitably need to take further down the line. Drawdown is not a one-and-done decision that retirees can make. They will need to ensure they are happy with their investments even as they age and their risk tolerance likely decreases, they will have to work out the impact on their fund and income if an unplanned expense such as long-term care happens.

Drawdown comes with a number of costs and until the industry are able to supply it at low-cost, then it will still be suitable mainly for the wealthy.

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Drawdown: still a retirement solution for the rich

Pension experts at Mercer have identified the countries with the best pension systems. At number 10 is Singapore.

The system is based on the Central Provident Fund, which covers everyone in a job. Some of the cash can be withdrawn during your working life, and a prescribed minimum drawn down at retirement as an income.

Overall, Singapore scored 65.9 out of 100. It fared well on sustainability measures, and integrity, but relatively low incomes in retirement dragged its combined score down.

The UK scored 67.6 out of 100. The system was ruled to have great integrity, and good incomes in retirement. The overall scores were also up from the year earlier, as auto-enrolment was rolled out further, bringing more people into workplace schemes.

The researchers, however, were worried about how sustainable the system would be in the future. They called for an increase in minimum pensions, and added that more people ought to be encouraged into workplace schemes and persuaded to contribute more to their pension. They also wanted to see more people saving privately for their pension, and working later in life.

In Chile the state offers means-tested assistance, a mandatory centralised pension for employees to contribute to, and there are voluntary employer schemes.

Chile score 68.2 out of 100. Its highest score was for integrity, with another good mark for sustainability. Relatively low incomes in retirement let it down, and the researchers said the biggest improvements would come from raising the contribution levels.

Canada has a universal flat-rate pension - with a means-tested supplement. There’s an earnings-related pension based on lifetime earnings, plus voluntary workplace and private schemes.

It scored 69.1 out of 100. Its best score was for incomes in retirement, while it also performed well for integrity. Its only relative weak point was how sustainable it might be for the future - particularly because older people don't tend to stay in work.

Sweden has an earnings-related system with notional accounts - although this system was introduced in 1999 so it’s still in transition from a pay-as-you go system to a funded one. There’s also a means-tested top up.

Sweden was given 73.4 out of 100. It scored excellently for integrity, and well for sustainability. The overall score was brought down by incomes in retirement, and the researchers called for more workplace and private pensions.

Switzerland has an earnings-related public pension, a mandatory occupational system and voluntary private pensions.

It scored 73.9 out of 100. It fared well for integrity and reasonably well for incomes in retirement. The researchers just questioned its sustainability.

Finland has a means-tested basic state pension and a range of statutory earnings-related schemes. It scored 74.3 out of 100.

It had high integrity scores, with a less positive result for incomes in retirement, and a surprisingly low score for sustainability. The researchers called for higher minimum pensions, higher mandatory contributions and encouraging people to work longer to improve sustainability.

The Netherlands has a flat-rate public pension and quasi-mandatory earnings-related occupational schemes - which are industry-wide defined benefit schemes based on lifetime average earnings.

The system scored 79.2 out of 100. All its scores were high - particularly for the integrity of the system.

The system in Australia consists of a government scheme, a mandatory employer contribution into a pension, and additional voluntary contributions from individuals.

It benefits from the fact that all workers have been automatically enrolled in their company pension schemes for some time, so participation rates are high. The minimum contributions have also been raised recently, which means workers are building reasonable retirement incomes. It had an overall score of 79.9 out of 100, with the only question mark being over sustainability.

Denmark’s system includes a basic state pension, means-tested state top-ups, a fully funded defined contribution scheme and mandatory occupational schemes.

The researchers said it was "A first class and robust retirement income system". It scored 82.4 out of 100, with high marks across the board.

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