A 10% fall in the first year of retirement could mean drawdown income runs out five years early


For adviser use only


We’ve done some work on working out what constitutes a sustainable income in retirement but here we ask what impact a market fall in the first year of retirement could have on their savings. How would your clients would cope financially if their drawdown income dried up five years earlier than expected? If your clients opt for a flexi-access drawdown product to generate an income in later life, experiencing such a shortfall is a very real possibility.

Let’s, for the sake of argument, say one of your clients is going to stop working when they turn 65. They invest £400,000 in a flexi-access drawdown product and they take an annual income of 4%. Working with EValue, we explored different market scenarios to see how long it might take them to exhaust their funds and for their income to dry up if they didn’t lower their income rate. 

Negative impact of an early fall in investment markets

We looked at low, medium and high risk investment portfolios and compared performance in median markets to those that experienced a 10% fall in the first year*.

In the low risk scenario, there was a one in 10 chance that the funds would be exhausted when the client was 92. But if there was a 10% fall in markets in the first year, then there was one in 10 chance the funds would run out five years earlier when the client was 87.

For the medium risk scenario, there was a one in 10 chance of the funds being exhausted when the client was aged 91, but they would be only 86 years old if there was a 10% dip in markets in the first year. For the high risk scenario, the ages dropped to 87 and 84 respectively.

Depending on the risk rating of their investment portfolio, a 10% dip in markets in the first year could, therefore, see a client run out of money five years earlier than expected.

Compound effect of drawing an income

If your client opts for a flexi-access drawdown product, they’re exposing themselves to the potential negative impact of a significant market downturn. The fact they’re drawing an income compounds the problem.

Cazalet Consulting also did an interesting piece of work** in this area. It assumed an initial investment of £100,000 and investment returns of 7% per annum compounded over 10 years. It also assumed an annual withdrawal of £7,000 was taken at the end of each year.

The model looked at three scenarios. One in which a consistent return of 7% was achieved in each year. A second using variable returns, with the highest return achieved in the first year and the lowest return achieved in the last year. The third scenario inverted the order of these variable returns, so that the lowest was achieved in year one.

The table below details the results: 

Sequence effect on residual fund: returns of 7% p.a., withdrawing £7,000 p.a.
Year7% p.a. deterministic7% p.a. high returns first7% p.a. low returns first
ReturnResidual fundReturnResidual fundReturnResidual fund
0   £100,000   £100,000   £100,000
1 7% £100,000 21% £114,000 -11% £82,000
2 7% £100,000 18% £127,520 -3% £72,540
3 7% £100,000 15% £139,648 3% £67,716
4 7% £100,000 10% £146,613 6% £64,779
5 7% £100,000 8% £151,342 7% £62,314
6< 7% £100,000 7% £154,936 8% £60,299
7 7% £100,000 6% £157,232 10% £59,239
8 7% £100,000 3% £154,949 15% £61,288
9 7% £100,000 -3% £143,300 18% £65,249
10 7% £100,000 -11% £120,537 21% £71,952

Source: Cazalet Consulting 

You can see immediately the impact that achieving poor returns in the early years has. In the third scenario – low returns first – the value of the investment has fallen to £71,952 after 10 years; whereas it has risen to £120,537 in the second scenario – high returns first.

A little further number crunching reveals the detrimental effect of withdrawing the annual income. If the client had not taken an income, the value of the investment in scenario two and three would have been the same after the ten years, £196,715.

But once you factor in the income withdrawals, the difference between the value of the investment in scenario two and three, at the end of the tenth year, is significant, a difference of £48,585.

The question, therefore, is how can you protect the retirement income that a client’s investment generates for the amount of time that they need it?

Exploring guarantees

One option is a guaranteed income drawdown product, for example, Aegon’s Secure Retirement Income. It offers the security of a guaranteed income and gives the chance to benefit from staying invested, so if your client’s circumstances change drastically, they can still get their hands on their remaining capital.

This sort of guarantee is so important because, without it, there is little to shield your client from a significant downturn in the market, at or in the early stages of retirement.

Another option is an annuity. This has the benefit of creating a guaranteed income for as long as your client lives, but severely reduces their access to capital while alive and the ability to pass on money to loved ones after their death. 

A guaranteed income can also form part of a blended retirement income solution that will enable clients to guarantee their necessary expenditure, then invest the rest in flexi-access drawdown to generate an income to cover discretionary spending.

 *Source: EValue. As at 30 May 2016. Returns include 0.90% product and fund charges, plus 0.5% ongoing adviser charge. Figures are based on asset allocations provided by EValue for a risk level 1, 4 and 7 investor (i.e. the bottom, middle and top of their seven point risk scale).

**When I’m Sixty-Four, September 2014, Cazalet Consulting