Annuity v Drawdown

simmogirl

Firstly may I thank all the knowledgeable posters on this site who have taught me so much over the years and especially recently when looking into my pension arrangements.

I am a 61 year old female drawing my state pension and my husband is 63 and drawing his occupational pension.

I am in the process of arranging an annuity or a capped drawdown pension. I have two funds that combined amount to approx £90k although this would reduce to £67k if I took the 25% lump sum. I have had an initial interview with a recommended IFA who I am comfortable with. I have over the years invested in stocks and shares isas and have avoided using a financial advisor. However I am convinced that using an IFA for my pension is a good idea. He has advised me that based on an enhanced annuity (level income) compared to Standard Life’s standard annuity rates he could increase my annuity by approx £500.

His fee for this is £1500. Having studied all Dunstonh’s comments re fee levels I suggested to my IFA that £1k would be a more acceptable fee and he accepted this figure. So thank you very much Dunstonh .

Joint pension income currently 21k net of tax plus approx £3k? to come from the pension funds under discussion. This will increase next year by £5k when husband reaches state pension age and by approx £5k in 2016 when a final salary pension pays out on my 65th birthday giving a total of approx £34k net. I have calculated that, even allowing for inflation, by the time my final pension pays out we should be covering our costs with our pensions. We live very comfortably on £30k pa.

We have cash savings of £150k and stocks and shares isas of 150k. Approx £50k of the cash is earmarked for spending on the house and children. I am in the process of converting the remainder of my investments into income producing funds. We take the income from the cash and investments to subsidise the current income shortfall.

I hope this provides sufficient background to enable you to make comments on my situation.

I have been reading up on Capped Drawdown and posed the question to my financial advisor who had discounted it at the initial interview. He has replied and summarised the pros and cons and also stated –

“The principle advantage is that you do not have to buy an annuity and if investment returns are good and interest rates rise you could take a much higher income in the future than would be available from an annuity. That said, anyone that has done drawdown over the last 15 years is probably worse off due to a combination of poor investment returns and declining interest rates over that period.”

The only comment I can make on this is that I assume I would invest my pension in income producing funds that would hopefully produce a rising income in line with inflation and that I would not be dependent on interest rates. Do you agree with the final comment that drawdown has not been successful?

He also stated that:-

“Due to the high risk nature of the drawdown and the need for initial and ongoing advice the costs of drawdown are a lot higher than purchasing an annuity.”

From what I have read here and elsewhere I am not convinced that I would need ongoing help with the drawdown pension although perhaps I would need it with the original setup. Is the fee of £1k reasonable should I decide to use the drawdown route as he will have had to produce all the annuity quotes before I make my final decision. I will ask him to confirm if that the £1k will include all his fees for investment advice etc in the setting up the SIPP.

He also states that it is usually better to have a minimum pot of £100k. Do you agree with this?

I have not signed any service agreement.

I am sometimes tempted to go the annuity route as it seems so much more straight forward but do object to signing away my pension funds.

Your comments on choosing annuity v drawdown would be much appreciated.

Any comments on my financial situation would also be gratefully received – I do think that I perhaps I have too much in cash.

mania112

Most things about Drawdown he has mentioned I agree with (and are factual):

Drawdown is suitable to those only with £100k+, that's industry standard wording. I'm not entirely sure why they say that - perhaps due to the risk of the fund falling and/or costs of that type of contract.

I agree that it's preferable to having ongoing advice on a Drawdown contract, to ensure the performance is as expected and to help you make investment-switch decisions. This could be done by yourself, and you seem to have experience with investments.

Drawdown leaves your fund invested (whereas an Annuity pays you an income for life based on your pension value, age, health etc).

The investments work (almost in) exactly the same way as they have done for the past X years when it was a personal pension, except now you can take an income from it. The funds themselves do not need to be income-baring funds. The provider will sell units of your funds to pay income.

Income is set by Government rates (known as GAD, Government Actuaries Department).

GAD VS Annuity depends on each individual and rates available at the time. But I would largely say, if you have no life-shortening illnesses, GAD will be able to provide a higher income than an Annuity (especially after 26th March when GAD rates will improve).

The point is risk and security.

An Annuity is fixed and cannot change, its risk free. At retirement, many people need the comfort this brings.

Drawdown is invested, they are investment-based risks and there are risks that the government change the level at which you can take income.

Death Benefits

An Annuity can offer up to 10 years of full pension to your spouse and between 0%-100% thereafter (different options offer different rates).

Drawdown offers the pension pot at death to your spouse, not the income that derives from it. If your spouse wants to continue with a Drawdown it will be free from tax, if your spouse wants the lump sum it will be subject to a 55% tax charge.

An Annuity can only provide income for your spouse, Drawdown can be passed to any beneficiary.

An Annuity is final. Drawdown can be converted to an Annuity.

kidmugsy

Why do you qualify for an enhanced annuity? I ask because a particularly efficient way of your buying yourself an inflation-protected annuity is not to use your pension pot, but to defer your State Pension for a few years. That yields an extra pension equivalent to buying an index-linked annuity at 10.4%p.a., which is wonderful value if (i) you live long enough, and (ii) the politicians don't invent some way to steal it from you in the future. The latter seems less likely than I used to dread, given that the proposed new State Pension scheme retains the feature of deferring State pension to earn Extra Pension.

So, if you expect to live longer than, say, 10 years, consider (a) deferring State Pension for a few years while living off the cash balance that you view as somewhat excessive, and (b) deferring crystallising your pension pot until you feel that you'd like to get your hands on the 25% lump sum.

As for annuity vs drawdown, it would be helpful to know (i) are you still earning, or are you retired? (ii) How well protected from inflation are (a) your husband's occupational pension, and (b) your future final salary pension?

As for the size of your pot, I am in drawdown on a pot smaller than your £67k and am happy with the costs. But then I'm not paying an IFA to tell me how to invest it.

GhIFA

The £100k guide figure tends to be where the fund in question is to provide the bulk of the income. In your case it will only be a small proportion so this figure is less of a "hard and fast" requirement, in my opinion.

sandsy

simmogirl wrote: »

The only comment I can make on this is that I assume I would invest my pension in income producing funds that would hopefully produce a rising income in line with inflation and that I would not be dependent on interest rates. Do you agree with the final comment that drawdown has not been successful?

The maximum income that can be taken from a capped drawdown is limited. And the limits are linked to interest rates so that's the relevance of interest rates. This is to try and ensure that drawdown fund doesn't expire before you do.....

simmogirl

Mania112
Thanks for the summary. I now understand why I had read that you should keep a cash amount in the Sipp - it is to avoid units being sold.

Kidmugsy
I have a few of the usual health complaints but hopefully nothing life threatening! I was asked to complete the form and have done so.

I am already drawing my pension although I understand your comment re deferring. I am not working.

Re deferring crystallising the funds in a Sipp. I have two funds that I could transfer to a SIPP. Do you mean that I can transfer 100% into the SIPP now and crystallise the pension and take the lump sum when it suits me? I understand that once I start to take income the right to take the lump sum is lost. Food for thought - thank you.

My husband's pension and my final salary pension are both index linked and although that only makes a contribution towards the effect of inflation it is better than nothing.

Which SIPP provider do you use?

GHifa
Your comment re the suggested £100k minimum pot for drawdown confirms my thinking - thank you.

Sandsy
Thanks for the explanation. My IFA said that I could probably take a max of 5% but I would limit myself at most to 4% less SIPP costs as this I believe is considered a sustainable rate.

Does anyone have any opinions re the IFA's comment that drawdown has not been successfull? Do you think his comments are related to drawdown plans that have been providing a main source of pension income?

mania112

I'm confused by the comment that Drawdown has not been successful over the last 15 years.

What does he mean by it?

The investments: They would have increased over the past 15 years.

The income: Has perhaps decreased, but you still have the income you haven't been able to take in your pension, you've not lost anything.

The big criticism over the years has been that Drawdown has left clients worse off than buying an Annuity. I've not seen any proof of that being the case and with Annuity rates not very attractive, I would be more confident to say the opposite is true.

GhIFA

mania112 wrote: »

I'm confused by the comment that Drawdown has not been successful over the last 15 years.

What does he mean by it?

The investments: They would have increased over the past 15 years.

The income: Has perhaps decreased, but you still have the income you haven't been able to take in your pension, you've not lost anything.

The big criticism over the years has been that Drawdown has left clients worse off than buying an Annuity. I've not seen any proof of that being the case and with Annuity rates not very attractive, I would be more confident to say the opposite is true.

My take on that would be that he hasn't been taking a 15 year view, but possibly making a judgement coloured by experiences of the last couple of years - where client's have had GAD reviews over the past couple of years they have had almost "perfect storm" of volatile equity markets, ridiculously low Gilt yields, and the reduction from 120% to 100% GAD maximum.

I met with a new client at the back end of last year who had been drawing the max income out of a plan that started in 2007, it was due for its first GAD review, and the income was going to drop by just shy of 50% - it was a difficult conversation for a first meeting!

mania112

^ Yeah, the firm I work for 'specialise' in pensions/retirement, we had serveral difficult conversation with people last year.

We're through the worst of it now, as clients are in the 3 year review period and have already suffered the 'perfect storm'