Withdrawing income from a Sipp in a bear market: dos and don'ts

What do those retiring in the UK against a backdrop of the coronavirus pandemic need to remember?

Investors who are building a future nest egg have time on their side and can ride out the sharp fall in risk assets. The situation for investors who are withdrawing an income from a self-invested personal pension is more nuanced.

Drawdown investors who have taken advantage of the pension freedoms that were introduced in 2015 have benefited from strong gains in the markets, so the underlying capital from which income can be drawn has likely risen strongly. This can be seen from the table showing average returns from funds in popular drawdown sectors. But we hope that Money Observer readers would have experienced far better returns by following Rated Funds and our model portfolios (especially the £10,000 income portfolios). 

Funds for a £10,000 income: three simple Rated Fund portfolios
11 investment trusts for a £10,000 annual income
10 shares to deliver a £10,000 annual income in 2020

In the midst of the first bear market since pension freedoms were introduced, the problem for investors who have only recently gone into drawdown or have not experienced decent capital gains could be acute, as the one-month performance figures suggest.

Analysis from investment platform AJ Bell reveals the impact a 20% fall in markets can have if it occurs in the first year a person enters income drawdown, assuming a £100,000 pension fund and drawing a 5% annual inflation-adjusted (rising by 2% annually) income and 4% average investment growth. For this person, the pension runs out after 18 years. However, when they are hit with a 20% loss in year 10 but make 4% average growth in others, their pension runs out after 21 years. In contrast, steady 4% annual investment growth sees the pension lasting for 25 years.

One solution is to only withdraw natural income, such as dividends, that the Sipp portfolio generates and to top this up only when capital values have risen strongly. 

The scenario illustrates the importance both of holding a cash buffer to ensure capital is not being eaten into during periods of market stress, and ideally of making a higher return than 4% a year. While that has been easy to achieve in the past decade, the next few years are likely to pose more of a challenge.

Average returns from funds and trusts in popular drawdown sectors

  % average return
(with income
reinvested) after:
Sector 1 mth 3 mths 6 mths 1 yr 3 yrs 5 yrs
IA Global -18.9 -13.4 -14.5 -4.7 4.2 34.4
IT Global -21.4 -16.8 -16.8 -9.7 7.6 43.8
IA Global equity income -19.8 -15.4 -16.5 -8.2 -3.4 23.2
IT Global equity income -22.6 -19.3 -17.8 -9.6 -1.5 30.9
IA UK equity income -24.8 -21.5 -19.2 -16.6 -14.2 -1.7
IT UK equity income -24.6 -21.1 -16.0 -15.9 -10.9 0.9
IA Mixed inv 20-60% shares -10.2 -7.3 -7.4 -2.3 0.6 12.4
IA Mixed inv 40-85% shares -14.0 -10.1 -10.3 -3.8 0.7 17.0
IT Flexible Investment -10.2 -7.3 -7.4 -2.3 0.6 12.4
Average returns from funds and trusts in popular drawdown sectors -14.0 -10.1 -10.3 -3.8 0.7 17.0

Notes: IA = Investment Association (for open ended funds); IT = Investment trusts. Source: FE Analytics, as at 12 March 2020.

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