Many people may need to reduce the income they are taking from their drawdown pension funds in light of recent falls in the value of their investments resulting from the economic impact of Covid-19.
The dramatic initial falls in equity markets were followed by some recovery and were by no means fully reflected in portfolios that were diversified into bonds and other assets. But there may, of course, be further fluctuations ahead.
The falls have reduced the value of people’s pensions, equity ISAs and investment portfolios. For those accumulating savings and contributing regularly to a pension, the general guidance has been to continue contributions and wait for asset prices to recover in the longer term.
The situation can be different, however, if you are taking regular withdrawals from your pension fund or other investments and you may need to review your pension planning.
Withdrawals from pension funds are typically derived from dividends, interest and sales of units in the funds you hold in your pension. That is how you are able to benefit from the total returns of capital and income generated by your pension portfolio. If fund values continue to rise reasonably steadily, the combination of income and capital withdrawals should provide a steady source of income.
But a sudden downturn means you would need to sell more units in your funds to support the same level of income. The losses would be crystallised and those units would no longer be in your pension portfolio to bounce back if the market improves again. The impact on long term values is much greater if the downturn, and the consequent sales of units at lower values, occurs early on in retirement. The technical term for this is ‘sequencing risk’.
Investors with well diversified portfolios have seen some of their holdings decline much less than other components in the portfolio. So the overall impact may well be much less than some of the headline figures, and withdrawals may not have a serious effect on future performance. The necessary rebalancing of portfolios may also allow withdrawals to come more from funds that have held up relatively well.
Many investors have some cash reserves that have been set up for such circumstances. If you are in this position, you might feel that it would be preferable to draw now on these cash reserves and wait for a time to make further drawings from your investments.
Under lockdown, our levels of spending have declined with sharp cut-backs on eating out, holidays, clothing and many other purchases. A temporary reduction in expenditure and plans for future spending may be a prudent strategy in the circumstances. There is also the possibility that some taxes are likely to rise soon to cover the costs of the pandemic.
Regardless of how you use your drawdown plan, it is essential to review the income you take from your investments on a regular basis. If fund values have fallen — or simply not grown as much as anticipated — you can act accordingly so that long-term plans are not jeopardised.
The value of your investment can go down as well as up and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance. Investing in shares should be regarded as a long-term investment and should fit in with your overall attitude to risk and financial circumstances.