SEQUENCING RISK
For those needing to draw a higher income in their retirement – whether temporarily or permanently – we will often use a Dual Account Drawdown model.
This is designed to shield your pension pot from depletion through what is known as ‘return sequencing risk’. This occurs when you may be selling your investments to fund your withdrawals during market fluctuations.
What is sequencing risk?
Sequencing Risk is the risk that you may be reducing the value of your pension in two ways at once.
The stock markets are prone to volatility, with ups and downs occurring as part of its regular cycle. At some points, the market value of your pension will decrease at the same time as you’re withdrawing funds as income.
Reducing its value in both ways simultaneously can have a knock-on effect on your pension fund’s future growth and could make it harder for your funds to bounce back when the market recovers.
If this occurs during the early years of retirement, it could significantly reduce the longevity of a portfolio. In a worst-case scenario, this may mean that you outlive your retirement savings.
How does the Dual Account work?
In Dual Account Drawdown, we use two accounts that work together to provide you with a regular income from profits accumulated from your investments, whilst shielding the growth portion from double depletion.
It is split into a ‘short term’ and a ‘long term’ account.
ACCOUNT 1
The short term account holds a balance of approximately five years’ income, which is topped up from your long-term account during healthy markets.
This is invested in short-term, less volatile investments, that aim to deliver a lower yet inflation-beating return.
ACCOUNT 2
Your long-term account is where the bulk of your funds reside, invested for growth over the long term.
This account is invested in higher risk fixed income investments and equity funds that, although more volatile, will aim to provide higher long-term returns.
What's the benefit?
During significant market downturns, you will simply withdraw your income from the short-term pot instead of the long-term account. It’s a win-win: you don’t have to pause or reduce your income withdrawals, and your investment holdings can remain in situ.
By doing so, your long-term account doesn’t experience the double whammy of withdrawals and the market downturn. This gives it a better chance of recovery and long-term growth.
The two-account process does not completely insulate drawdown investors from the stock market volatility. However, it can significantly reduce the sequencing risk, increase the overall returns, and improve your retirement outcome.
This approach won’t be right for everybody and isn’t necessarily superior to traditional drawdown methods. Your wealth manager will advise on the appropriate strategy for your specific needs and circumstances.
How could a Dual Account benefit you?
Try our Drawdown Calculator to see how this system could benefit you.