Trapped again

By JEFF PRESTRIDGE, MONEY EDITOR AT LARGE
Updated:

 

Just four years ago income drawdown was seen as the answer to many people's retirement fears. It seemed to offer the holy grail of income from a personal pension without being locked into a poor-value annuity.

Today, income drawdown, or pension fund withdrawal as it is also known, is dogged by controversy.

Rumours abound of widespread misselling, fuelled by big commission payments to financial salesmen who steer clients away from annuities and towards income drawdown.

Horror stories are also beginning to emerge of investors who have had their fingers burned because of inappropriate advice on income draw-down. Some have seen their pension funds savaged by poor investment performance or have had to take big cuts in income to stop their pension funds dwindling.

In theory, income drawdown makes sense for many people, especially those who retire early.

Under the traditional pension annuity route, an individual pension fund is converted into a lifetime annuity - an investment that produces a regular fixed income.

The downside is that the customer is stuck with the annuity for life and cannot exchange it, even if it was bought when rates were low. But with income drawdown, customers have greater flexibility. They can delay taking an annuity until age 75 while drawing income from their pension through the encashment of units in the fund.

The idea is that the rest of the fund will be invested to generate enough to cover the withdrawals, preserving value of the fund. This leaves the way clear to convert the fund to an annuity at the best time - when rates are high.

Unfortunately, the theory has not lived up to its promise. Indeed, many of the perceived attractions of income drawdown are turning into disaster.

Earlier this year, a survey by leading personal finance magazine Money Management revealed that because investment returns had fallen below expectations, more than 50% of those who had signed-up for income draw-down soon after its introduction had been forced to reduce their income to preserve the value of their funds.

Money Management identified Equitable Life, Legal & General, National Mutual, Scottish Equitable and Winterthur Life as companies that had asked investors to take payment cuts.

One income drawdown customer who has suffered a painful drop in income is former company director John Furman. In early 1996 he was advised by a Legal & General salesman to put his £201,000 pension fund into an L&G income drawdown scheme.

John, 63, has had a traumatic time since. His income drawdown pension was invested 30% in a high-risk Far East fund, even though he had little previous experience of investing in equities. The balance was put into Legal & General's conservatively managed distribution fund.

Because of the economic collapse of the Far East, his total pension fund is now worth £159,179. Also, after the three-year review that pension companies are obliged to make, he has been forced to take an income cut from £18,752 a year to £13,038.

John, who lives in Helston, Cornwall, is devastated. He and his wife Rita, who still have a mortgage, may have to sell their home and move into a cheaper one to reduce their outgoings.

'The risks associated with what I was doing with my pension were never fully explained to me,' he maintains.

'With the benefit of hindsight, it is clear that I would have been better off buying a traditional annuity. Indeed, if I had done so three years ago, I could have bought an annuity that paid £16,000 a year guaranteed for life. A future of certainty has suddenly been turned on its head. Now I view the financial future with trepidation.'

John has made a formal complaint to the Ombudsman at the regulator Personal Investment Authority and is waiting for his verdict.

Graham Bates of financial adviser Bates Investment Services in Leeds has taken up the case, which, he says, demonstrates the big flaws in income drawdown.

'Four years ago, many people became income drawdown guinea pigs,' says Bates. 'Unfortunately John Furman was one of them.

'Of course there is a role for income drawdown, especially among the wealthy who can afford to take risks with their pension. But for most people it should be a non-starter. Retirement is simply not a time when people should be taking big financial risks.'

L&G says it would be inappropriate to comment on the Furmans' case, but adds: 'Annuities are a safe option, providing a guaranteed income in retirement. However, income drawdown carries greater risks, so it is essential that customers go into it with their eyes open and are fully aware of these risks.'

Steve Brady, pensions special-ist at Chartwell Investment Management in Bath, Somerset, believes income drawdown plans are being bought as a result of a misconception.

He says: 'Nearly everyone I sit down with to discuss a pension starts with a view that an annuity is going to be a bad deal. As a result, they see income draw-down as the answer to their retirement prayers when often it is not.

'They simply do not understand the big risks involved.

'It must also be said that income drawdown is often promoted for the wrong reasons. If an adviser can earn only 1% commission for setting up a pension annuity but can receive up to 6% for arranging income drawdown, it is obvious that many are going to sell drawdown irrespective of its dangers.'

Stuart Bayliss, pensions expert at Annuity Direct in London, believes that income drawdown has missed the target.

He says: 'It cannot be right that we have legislation that forces company pension trustees to restrict investment risk within their funds to take account of people approaching retirement, while on the other hand, we have income drawdown, which is encouraging people to take higher investment risks as they retire.

'This may not be a scandal, but it is an issue of grave concern that must be addressed urgently.

'Income drawdown must be over-hauled before the pensions industry has more sad cases like John Furman's on its hands.'

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