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Back to the drawing board for drawdown illustrations

31st Jul 2014

Article by Nigel Chambers from Citywire

Drawdown illustrations face significant hurdles if retirees are to exercise their pension freedoms without becoming confused and running down their funds.

 

Investment illustrations are already flawed when it comes to decumulation. Returns may turn out to be less than expected if the principal is reduced by drawdowns or losses. A 6% gain in each of two years leaves a pensioner better off than a 6% loss in year one followed by a 18% gain in year two.

 

It is a requirement that all pre-retirement illustrations must now be presented on an inflation-adjusted basis. This means the illustrations will sometimes show that, after years of saving, an investor gets back little more, or even less, than they put in.

 

While the FCA has not made it compulsory to apply the same type of inflation adjustment for drawdown illustrations, a small number of providers have chosen to do so. This must be incredibly confusing for an adviser attempting to compare products. 

 

Important illustrations

 

Discussion about how best to illustrate the advantages of drawdown has become much more important following the Budget announcements.

 

There will no longer be a requirement for pension funds to last for the rest of a person’s life, so the most widespread danger might not be from people blowing their pot on a Lamborghini but poor investment outcomes. 

 

It is important for investors not just to understand the difference between taking an annuity and leaving a fund invested in drawdown but also to be able to compare a drawdown investment with a transfer to an ISA or building society investment.

 

Complex comparisons would become even more opaque if they had to be done on an inflation-adjusted basis, particularly as it is only the pension investment products for which there is any requirement to make such an adjustment.

 

It is to be hoped the FCA does not make further changes to the drawdown rules at a time when the industry is trying to find ways to deliver the new flexibilities at-retirement that were a welcome announcement from the government.

 

Original article here

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