Laura Suter: How has investor behaviour changed since pension freedom?

Four years on - give or take - from the launch of pension freedom, Laura Suter avoids any digs on the number of Lamborghinis bought since April 2015 and instead focuses on how investors' behaviour has changed

Far from pension freedom leading to extremes of everyone draining their pot and splurging the money – though undoubtedly there must have been examples of that – investors appear to have withdrawn their cash at relatively sustainable rates and, what is more, they have reacted to worsening market conditions.

Over the past year, for example, pensioners have dialled down both their regular withdrawals from their pension pots and also their expectations of what returns they will see on their pot. The latest tranche of research run by AJ Bell shows that, on average, people are taking 4.7% withdrawals from their pot each year – a drop of a third from 12 months ago.

So is 4.7% still a bit too bullish in the current wobbly market environment? The rate of withdrawal from pension pots, post freedom, has been the subject of reams of research and articles but, going by a few rough rules of thumb, it does not seem too ambitious.

The FTSE 100 is currently yielding 4.9% for example, so it is not unrealistic to draw the natural yield off a portfolio and not touch the capital – though, admittedly, anyone with their entire pension pot in the FTSE 100 has bigger problems on their hands.

If a client has a £500,000 pot, a 4.7% withdrawal represents £23,500 a year income. If you assume a 60/40 split between stocks and bonds (we can debate whether that is still realistic another time), with shares returning 5.3% and bonds 4.4% (based on long-run actual average return figures) and charges of 1.5%, what are you left with?

On those assumptions, the pot would last 35 years – by which point the client would have just shy of £15,000 left. Assuming a retirement age of 65, they would be at the ripe old age of 100 – or more likely, based on currently mortality assumptions, dead. So 4.7% is not outlandish.

Pound-cost ravaging

These figures ignore pound-cost ravaging, however. And our findings show that one in 10 pensioners in drawdown have seen a big drop in fund value, which has led to them cutting their withdrawals. These are the folks that get a gold star.

A larger proportion of people, however – 30% to be exact – have no idea what has happened to their pension pot since they entered drawdown. These ostrich-like retirees could face a nasty surprise around the corner if they maintain their withdrawals at unsustainable rates.

Let’s look again at our example from earlier but, instead of the pension pot gradually rising with investment returns, let’s assume it falls for the first three years, by a modest 3%, and then resumes the previous returns as before.

If the withdrawal rate remained at 4.7% the pot would run out after 24 years, when the client would have just over £19,500 left – in other words, effectively shaving a decade off your retirement. Considering all major markets returned a loss last year, that is a very real possibility for those retirees who refuse to check their accounts or change their withdrawal rates.

Laura Suter is a personal finance analyst at AJ Bell