Do I have to buy an anuity or income drawdown?

Hardy7

I have been reading about pensions and what I have read seems to say this:

1. You can access your pension pot from age 55 or older.
2. You can can only take out 25% as cash to invest it as you want. The rest must buy an anuity or income drawdown (DD).
3. Once chosen the annuity cannot be changed or undone.
4. Apart from health or other factors, 6% is about as much as you can expect from an anuity.
5. An anuity only pays out during your lifetime, or a joint life or guaranteed anuity only pays out the anuity to your spouse during their lifetime, or to another dependant for a fixed number of years. In all cases the pot is eventually lost (kept by the anuity provider) and cannot be passed on as an inheritance.
6. With an income drawdown (DD) the income you can draw is a set percent of the fund, and after your lifetime only 45% can be passed on (the rest is taxed) and as with anuities the pot is eventually lost.

It looks inflexible and not worth it for the short term tax break when you pay in to the pension.

I know anuity and drawdown is the 'safe' option. But do you have to buy an anuity or income drawdown? Can you pay into a pension, and then put the pension pot into high dividend yield shares, property, or equity income funds? (Or all three). This would be more flexible, allowing for changing your mind later, and the returns on dividend high yield shares or equity income funds seems to match the amount you can expect from an anuity - but without the tie in and inflexibility. Plus the assets won't be lost after your lifetime. Can I do this?

Linton

Some points you may not have considered:

1) Your employer may well contribute to your pension, sometimes substantially. Employers will be forced to contribute to pensions over the next few years.
2) The tax break can be significant eg for higher rate tax payers.
3) The 25% you can take as cash is tax free
4) With income drawdown, after your death the pot can be passed to a spouse/dependent tax free as a pension pot.
5) If you die before taking your pension the pot is paid out, normally in accordance with your wishes, tax free.

On your final question - you can of course invest your pension pot in income funds, dividend paying shares etc. However the gains remain within your pension and can only be paid to you via drawdown. Drawdown is the method by which cash is transferred from your pension to you.

From your comments you seem to be more concerned about saving for your descendents' inheritance rather than supporting you during your old age. If that is the case then dont go for a pension as that's not what they are for. However if you want to provide for your old age, pensions have great advantages for most people.

Hardy7

Linton wrote: »

Some points you may not have considered:

1) Your employer may well contribute to your pension, sometimes substantially. Employers will be forced to contribute to pensions over the next few years.
2) The tax break can be significant eg for higher rate tax payers.
3) The 25% you can take as cash is tax free
4) With income drawdown, after your death the pot can be passed to a spouse/dependent tax free as a pension pot.
5) If you die before taking your pension the pot is paid out, normally in accordance with your wishes, tax free.

On your final question - you can of course invest your pension pot in income funds, dividend paying shares etc. However the gains remain within your pension and can only be paid to you via drawdown. Drawdown is the method by which cash is transferred from your pension to you.

From your comments you seem to be more concerned about saving for your descendents' inheritance rather than supporting you during your old age. If that is the case then dont go for a pension as that's not what they are for. However if you want to provide for your old age, pensions have great advantages for most people.

Thank you for the detailed points. I am not sure if the answer is 'yes' or 'no' to my question.

Does this mean that if you pay in to a pension you must buy an anuity or a draw down? It is possible to put money in to a pension and then take it out and buy high yield shares, or property, or put the money in an equity income fund, and live off the income they generate?

richbeth

Hardy7 wrote: »

Thank you for the detailed points. I am not sure if the answer is 'yes' or 'no' to my question.

Does this mean that if you pay in to a pension you must buy an anuity or a draw down? It is possible to put money in to a pension and then take it out and buy high yield shares, or property, or put the money in an equity income fund, and live off the income they generate?

A pension is a tax wrapper so there is no need to take money out to buy the investments you mentioned apart from residential property which cannot be held in a pension.

You should look at the details of how much you can drawdown from a pension and the mechanism for this as this may help your understanding. In drawdown you are taking out the dividends etc (inc capital) from the investments which seems to be what you want (there is an annual limit depending upon other income you may have). Also any funds left in the pension pot after you die go to your dependents but there is a tax charge which someone more knowledgeable than me can explain.

If you take an annuity nothing none of the pension fund is left to your dependents but you can opt to have your spouse receive an ongoing pension. this will reduce the amount of your annuity though.
R

Linton

Hardy7 wrote: »

Thank you for the detailed points. I am not sure if the answer is 'yes' or 'no' to my question.

Does this mean that if you pay in to a pension you must buy an anuity or a draw down? It is possible to put money in to a pension and then take it out and buy high yield shares, or property, or put the money in an equity income fund, and live off the income they generate?

The only way you can take money out of a pension is via an annuity or drawdown. You can buy high yield shares, income funds or investments in commercial property within your pension: indeed this may well be a very sensible thing to do. But the gains stay within your pension; to actually get your hands on cash requires an annuity or drawdown. (or to suffer ill health sufficient to persuade a doctor that you will certainly be dead in a few months). Having got the cash out you can then also use it to buy further investments. However it does not seem a very sensible thing to do - why take cash out of a tax protected environment if you dont need it?

One other point I forgot to mention. A significant danger with not having a pension is that you will be one of the 50% of the population who live longer than average and you run out of money. Pensions, particularly annuities, protect you from that as the money from people who die early is not used to enrich the pension companies but rather to subsidise those who live too long.

atush

That is what a Drawdown is- you invest the money as you like (income funds or high yield shares) then live off the income.

But no, you cannot take the money out of the pension to do this (but then again you don't need to). But, the 25% Tax free LS is outside the pension to be invested or spent or given away as you like.

And as said above, if you use DD over an annuity, the whole pot can be left to a spouse or dependents w/o tax charge if they leave the money as pension.

Hardy7

Linton wrote: »

The only way you can take money out of a pension is via an annuity or drawdown. You can buy high yield shares, income funds or investments in commercial property within your pension: indeed this may well be a very sensible thing to do. But the gains stay within your pension; to actually get your hands on cash requires an annuity or drawdown. (or to suffer ill health sufficient to persuade a doctor that you will certainly be dead in a few months). Having got the cash out you can then also use it to buy further investments. However it does not seem a very sensible thing to do - why take cash out of a tax protected environment if you dont need it?

One other point I forgot to mention. A significant danger with not having a pension is that you will be one of the 50% of the population who live longer than average and you run out of money. Pensions, particularly annuities, protect you from that as the money from people who die early is not used to enrich the pension companies but rather to subsidise those who live too long.

So simplistically: if I have £50,000 I can either invest it however I want, and for arguments sake, get 6%, so £3,000 income per annum. The capital remains, but at any point I can take the £50,000 and invest it somewhere else, or spend it, or leave it as part of an inheritance in which case a spouse or dependant gets the £50,000 (if under the inheritance tax threshold) and could continue to benefit from the 6% £3,000 a year.

The same £50,000 put in a pension could be a pot of £50,000 + 20% tax relief = £60,000, but has to be used for an anuity or drawdown, giving at best 6%, so £3,600 income per annum. Or I can take 25% out (£15,000 cash) and get £2,700 income per annum. But the capital is locked away and cannot be spent or invested elsewhere, or left as an inheritance. At best the anuity can continue to be paid to a spouse or dependant for a number of years but the anuity even on the full £60,000 would probably be less, say 4% so only £2,400 per year.

The pension seems to offer only a little improvement in income, and 6% anuity is probably being generous. If the same £50,000 was invested in high yield stocks and a reasonable mix of shares it would probably return 6% or more over the long term. The pension looks to be very limiting and potentially less rewarding.

jamesd

Hardy7 wrote: »

6. With an income drawdown (DD) the income you can draw is a set percent of the fund, and after your lifetime only 45% can be passed on (the rest is taxed) and as with anuities the pot is eventually lost.

Corrections:

1. The percentage varies and increases with age.
2. 100% can be passed on to a spouse into a pension pot in their own name. Taken outside a pension there's a 55% tax charge, whether it's going to a spouse or someone else.
3. The pot is not eventually lost, it gets inherited by someone.

Hardy7 wrote: »

But do you have to buy an anuity or income drawdown? Can you pay into a pension, and then put the pension pot into high dividend yield shares, property, or equity income funds? (Or all three).

That is what income drawdown is. You buy investments like those and take an income from them if you want to. You get to pick the investments, except you can't pick residential property. Want shares in individual companies? Fine, go ahead with income drawdown. Same for funds, ETFs, covered warrants, options and commercial property even with a mortgage.

Hardy7 wrote: »

Plus the assets won't be lost after your lifetime. Can I do this?

Of course! Income drawdown seems to do just what you're after.

saintalan

Hardy7 wrote: »

I have been reading about pensions and what I have read seems to say this:
...

Hi Hardy welcome to the Forum.

As you are not giving your circumstances and just wanting to understand the options, I thought I would just add, as I dont see it above, that there are 2 types of DD i.e. Income & Flexible.

Flexible Drawdown is where, providing you meet the requirement (already receiving £20k in pensions pa) you can take all of your pot subject to tax.

I mention just for your reading.

Cheers

Alan

jamesd

Hardy7 wrote: »

The same £50,000 put in a pension could be a pot of £50,000 + 20% tax relief = £60,000.

No. 20% tax relief increases it to £62,500. You add 25% to the amount you put in to get the same as taking 20% off the gross amount.

Then you can take out 25% tax free and use that for anything at all, £15,625 worth. The remaining £46,875 can be invested in all of the popular investment options, shares, funds, ETFs etc. and inherited 100% by a spouse into a pension pot or after 55% tax charge to anyone outside a pension pot.

Hardy7 wrote: »

the capital ... cannot be ... left as an inheritance

Yes it can. 100% to a spouse in a pension pot in their name, 45% after a 55% tax charge to anyone outside a pension pot.

Hardy7 wrote: »

If the same £50,000 was invested in high yield stocks and a reasonable mix of shares it would probably return 6% or more over the long term. The pension looks to be very limiting and potentially less rewarding.

Hardly. You can use the same high yield stocks and a reasonable mix of shares inside the pension and their return would be exactly the same.

The drawdown rules limit how much can be taken out of a drawdown pension each year. Any gains above that just stay in the pension to be taken later.

At the moment a 55 year old can take out 5.28% a year. That's in part because gilt yields are very low at the moment, it's normally more like 1.3 times that. Even with current gilt yields that rises every year to 6.72% at 65, 9.6% at 75 and 17.16% at 85. Normally recalculated once every three years until 75 but you can do it annually if you like.

Also remember that those are percentages of the 25% bigger pension pot, so they are increased compared to other options by that.

Now that's Capped Drawdown. If you have a total of at least £20,000 in state pensions, work final salary or other defined benefit pensions or from annuities you can use Flexible Drawdown. That lets you take all of the money out of the pot at once if you like. No limit at all. You're still taxed as income on the amount you take out each year, of course.

dunstonh

If the same £50,000 was invested in high yield stocks and a reasonable mix of shares it would probably return 6% or more over the long term. The pension looks to be very limiting and potentially less rewarding.

That is because you are wrong. You are forgetting tax relief, tax free growth (no income tax liability, no CGT, no IHT if you die) and that you can take out 25% tax free on retirement.

Put the same investments in the pension and you get the same rate of return. The only difference is the tax and maturity process.