The days when most pensioners bought an annuity at retirement to pay them a guaranteed income for life have gone for good. Today, most retirees leave their pension savings in drawdown, allowing them to carry on growing as stock markets rise. While this can bring rewards, it also has dangers.
Drawdown is riskier than buying an annuity, because neither your capital nor the income it generates is guaranteed.
If you make too many withdrawals too soon, or the stock market crashes at the wrong time, it could wipe out your pension pot.
Earlier this year, we reported that the typical pensioner risks running out of retirement income seven years before they die.
The typical retirement lasts around 20 years yet pensioners have only saved enough money for 13 years of spending, according to financial planner Money Minder.
Many could end up with only their state pension in their final years.
The danger is growing as new research shows that “golden oldie” investors are taking big risks with their money in a desperate bid to produce a higher return.
Many are throwing money at “juggernaut” US tech stocks appreciate Nvidia and Microsoft to cash in on the artificial intelligence (AI) revolution, said Emma Wall, head of investment analysis and research at Hargreaves Lansdown.
She said drawdown investors “are loading up on risk to fund their retirement” and have dangerously “bullish views on the market”.
They are “defying basic investing rules” by taking MORE risks as they get older, rather than fewer.
Traditional financial advice suggests “de-risking” investments as you get older, when you have less time to recover from a stock market crash.
Younger investors can afford to take a punt on tech stocks and more volatile assets because they may not need their money for years or even decades.
Older investors aren’t following the rules, Wall said. “Despite stubborn inflation, compelling cash rates and a hazy economic outlook, our drawdown clients are looking to AI stocks to fund their retirement.”
As well as buying individual stocks, many are buying volatile tech funds such as the World Legal & General Global Technology Index Trust.
That was the most popular investment fund among older investors in November, while high-risk fund Jupiter India was also in the top three.
Wall urged investors to consider their goals and “appetite for loss” before investing. She warned that US shares now look expensive with tech stocks Nvidia, Microsoft, Apple, Amazon, Tesla, Google-owner Alphabet and Facebook owner Meta “all trading at significant higher valuations compared to the rest of the market”.
She added: “Every portfolio should have a good allocation to the US, but we would encourage investors to diversify their risks to include other styles, sectors and countries.”
Markets have rebounded strongly in recent weeks but that may quickly reverse if share prices crash. Experts warn that drawdown investors face two more risks.
READ MORE: Tough annuity choice. Lock into income for life or gamble on drawdown
The first is overestimating how much money they can withdraw each year, said Gary Smith, retirement specialist at UK wealth manager Evelyn Partners.
Many follow something called the “four percent regulate”, which says if you take that percentage of your pension each year as income, your capital will never run out. If inflation averages three percent you will break even provided your portfolio grows by seven percent a year.
Yet share prices crashed in 2022 while inflation rocketed to a peak of 11.1 percent in October last year, blowing a hole in the regulate.
Smith said a much lower three percent withdrawal rate “is probably a safer bet” but HMRC figures show that pensioners are withdrawing eight percent a year in practice. They risk running out of money as a result.
The third drawdown risk is that many savers falter to account for how inflation shrinks the value of their money, according to new research from People’s Partnership and State Street Global Advisors.
People’s Partnership director of policy Phil Brown said pension savers tend to progress an “inflation blind spot”. “As a result, there is a real danger that some retirees will have less in their pockets over the longer term than they first anticipated.”
Drawdown offers rewards but it is also complicated and requires planning to make sure your savings last as long as you do, whatever stock markets and inflation send our way.
