February 2, 2008

Share price falls erode income drawdown plans

When stock markets fall, one of the biggest triggers of panic for private investors is the thought that their retirement savings are being chipped away before their eyes.

Company pension schemes have been badly hit by the recent stock market weakness and many private investors will also have seen a large chunk of their retirement pot eroded in the last few weeks.

"Most people have some equity aspect in their pensions, and so will have seen a fall," says Neil Marsh at Hornbuckle Mitchell, the pension provider.

But for many retirement savers, these patches of market volatility should not be too big a concern. Pensions are long-term investment vehicles and advisers are confident that equities are still a good long-term bet. As long as you can afford to ride out the volatility, there is no immediate need to worry.

Those most at risk are people who are approaching retirement or already taking pension benefits.

Since A-day in April 2006, investors have been able to keep their pension funds invested at retirement and take a percentage of their pot as income each year, rather than buying an annuity. This means that instead of having a predetermined income for life, the amount of income they can take each year depends on the performance of their underlying investments.

People who have purchased an annuity will see no change, as this guarantees a set income for life. But anyone who has opted for income drawdown might find their savings are depleted.

The worst hit will be those who are still aggressively exposed to equities. Investors on the brink of retirement may have to defer taking benefits until stock markets recover, or take a lower level of income than they had planned.

"If people want to preserve what capital they have left, it might mean taking a smaller income," says John Moret at Suffolk Life.

Investors who have already been taking income at or close to the maximum level may find they cannot take as much over the next year as their remaining funds may be worth less.

People who now feel they are over-exposed to equities, and therefore vulnerable to further falls, may look to move some of their assets into safer areas.

Some equity exposure is, however, considered sensible in income drawdown as the funds may have to last for more than a decade.

Peter Hicks, executive director of UK retail at Fidelity, believes a 30 per cent exposure to equities is probably about right. In reality, he says people close to retirement can still have as much as 100 per cent of their portfolios invested in equities.

"It is difficult when markets have gone up for four and a half years in a row," he says. "People might have underestimated the risk they are taking. The last few weeks and months have reminded us of that risk."

Advisers say private investors also risk getting asset allocation very wrong. Many move into riskier assets at the exact time they should avoid them.

Pension investors should generally be heavily geared to equities when they are a long way from retirement. It is generally worth taking more risk earlier on as there is plenty of time to ride out the peaks and troughs of the market. The closer they get to their retirement date, the more they should be looking at safer assets, such as cash and bonds. This shift in asset allocation is known as life-cycle investing.

Ian Price, head of pensions at St James's Place, says more people are following this pattern, and are moving to fixed income as they draw closer to retirement.

"But some still choose to run the gauntlet and keep their funds in equities later on," he says. "Some people keep moving their retirement date later and later and try to make their funds go further by being quite adventurous."

Hicks says private investors are often tempted to go into fashionable investment areas without thinking about their overall asset allocations. Judging by the performance of some of last year's most popular areas - emerging markets and property funds, for example - this may not be a good move.

Price says there is also the danger that people forget about their pension investments.

"These kinds of market movements should remind them to keep a close eye on where they are invested, and make sure their assets are in the right place at the right time," he says.

It is not just direct equities that have been hit by the recent market falls.

Marsh at Hornbuckle Mitchell says with-profits investors are also having a torrid time. With-profits funds aim to smooth out the ups and downs of the stock market. But when markets fall sharply, insurance companies can slash terminal bonuses or introduce penalties for investors who try to encash their funds.

"Terminal bonuses are now under threat," says Marsh. "People close to retirement who are counting on a large terminal bonus may want to switch investments."

But for pension investors who are still some years from retirement, there is little need to change their objectives.

Advisers generally think that anyone at least five to 10 years away from retirement should have long enough to make up any losses.

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