Do I have to buy an anuity or income drawdown?

Linton

Hardy7 wrote: »

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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.

There is something basic here that you havent twigged. Why do you think you are limited to 6% in a pension???? You can buy exactly the same things in a pension as you can in an ISA. If high yield stocks is what you want you can buy them in a pension wrapper in much the same way as you can in an ISA or with a simple online brokers account. So the investment returns from a drawdown pension are no different to those from any other form of investment.

Actually a pension is rather better than an ISA:
1) It isnt limited to £11k/year
2) You can buy things in a pension you cant in an S&S ISA - eg AIM shares or a cash account.


If you want to consider annuities you cant simply compare long term returns. The key feature of an annuity is that it is a guaranteed regular payment for as long as you live no matter what happens to the stock exchange or the economy. Your 6% from shares is a long term average, if you happen to hit the occasional credit crunch or tech boom crash and have no other income what do you do? Stop spending? Taking a fixed 6% income stream from investments is a good way to run out of money - see Firecalc. It's in $'s but it's still highly relevant.

Hardy7

jamesd wrote: »

Corrections:

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

So I can put money into a pension and get the 20% tax benefit now, so my £50,000 means £60,000 into the pension fund. Then at 55 when I want to start drawing an income from the capital that has hopefully grown, I can put that capital into stocks and shares of my choice (probably a dozen high dividend yield shares) or put the money into an equity income fund. No anuity in sight? Lets say I don't want to take out 25% at the start and want the full amount to remain invested.

a) What happens to the fund if I do not withdraw any regular income but leave dividends or share price increases to be reinvested?
b) How much can I take out each year as income, and how much of the total fund can I withdraw and spend (if I wanted to), and how much of the fund can be passed on as an inheritance for the beneficiary to withdraw as cash and spend (if they want) or invest as they choose?

jamesd

Close. Your £50,000 means £62,500 into the pension fund after basic rate tax relief is added.

Yes, no annuity in sight. Just to give you some idea I have around twenty investments in my own pension that will be used for drawdown. Those include equity income funds, emerging markets funds, a Vanguard tracker, a global tracker ETF and a doubly leveraged ETF tracking the FTSE All Share Index.

a. It just grows. You don't have to take income if you don't want to.

But if you're still working it's probably better to take the income and use it for more pension contributions. That gets you a new pension pot and new tax relief that you can take another tax free lump sum from, a nice bit of extra tax gain. This is one of the "tricks" that increases the value of pensions.

b. For income, use the calculator I linked to. I gave some examples at the current gilt yield. Or look at the table in this post, use the 2.5% gilt yield row, and multiply the incomes by 1.2 to get current values.

After taking out the 25% you can't take out more than the annual limit each year, either as a lump sum or as income.

A beneficiary if a spouse can get 100% and they then get the same investment or buy annuity options as you. If they want it outside a pension pot or if you have someone inherit it outside a pension pot they get 45%.

There's an exception to the annual limit. If you're diagnosed as having a medical condition where doctors think that there is a high chance of dying within a year you can take it all out.

Linton

Hardy7 wrote: »

So I can put money into a pension and get the 20% tax benefit now, so my £50,000 means £60,000 into the pension fund. Then at 55 when I want to start drawing an income from the capital that has hopefully grown, I can put that capital into stocks and shares of my choice (probably a dozen high dividend yield shares) or put the money into an equity income fund. No anuity in sight? Lets say I don't want to take out 25% at the start and want the full amount to remain invested.

a) What happens to the fund if I do not withdraw any regular income but leave dividends or share price increases to be reinvested?
b) How much can I take out each year as income, and how much of the total fund can I withdraw and spend (if I wanted to), and how much of the fund can be passed on as an inheritance for the beneficiary to withdraw as cash and spend (if they want) or invest as they choose?

£50K payment actually means £62.5 into pension as £62.5K -20% = £50K assuming you are a standard rate tax payer.

With income drawdown you can take the money from say high yield shares. It will be subject to income tax. The reason for taking the 25% cash is that it's tax free. All other payments from a pension are subject to income tax. So in general it would be sensible to take the money.

Qa) The pension pot gets bigger. You can invest your gains as you wish within your pension
Qb) This is limited by what are called the GAD rules. Google will provide the details. The purpose of the limit is to prevent you using up all your pension quickly and then rely on state benefits. If you have more than £20K of other guaranteed income including state pension there is no limit. The value of the limit is fixed by Government actuaries and is typically somewhere between the return from an inflation matching annuity and a fixed rate annuity. In practice it should mean that you can get somewhere near a fixed rate annuity income increasing broadly with inflation.

Given the GAD limit, unless you are a hopelessly incompetent investor, you are very unlikely to use up all your pension pot. On your death whatever remains in the fund can pass as cash to your beneficiaries outside your estate but with a 55% tax take. 55% sounds high but it corresponds to repayment of the 20% tax benefit and 40% inheritance tax. The idea being to prevent pensions being used as a tax loophole to avoid inheritance tax. This provides another good reason to take the tax free 25%.

Hardy7

These GAD rules seem to add another restriction on pensions. Essentially it looks like no matter how well your pension pot does or grows, you are never allowed to take more than the GAD limit each year. I ran a calculation on a GAD calculator and it suggested if the pension pot was £100,000 you could only draw a maximum £5,500, 5.5% a year. It went on to say:
"Withdrawals and stock market movements will reduce the value of your pension fund and therefore the maximum income you can receive in the future may fall."
Why will stock market movements automatically reduce the value of my pension fund? If the market goes down I can see that would happen, but what if the market goes up? What happens if for example there is a long bull market run and the fund is increasing 8-10% per year compound. Is the pensioner still restricted to withdrawing only 5.5% (of the increasing pension fund) but the additional growth has to stay locked in?

GhIFA

GAD rates differ with age, as you get older they should increase, and therefore allow you take a greater proportion of your fund as income. The maximum amount of income you can draw is reviewed every three years, and based on the prevailing GAD rate for your age at the point of the review.

Whether this increases or decreases the income you can take will be determined by the investment performance of the fund in relation to the amount you have been drawing in income between the reviews.

jamesd

You're never allowed to take out more than the GAD limit after taking the lump sum but do you really plan on dying before you reach 85, when you can take out 17% of the pot each year? You're not really likely to consistently grow it faster than that and more than half of people in decent health at 65 live longer than that. You might manage the 9.6% at 75 (and increasing with age each year after that if the gilt yield remains the same) but it's not certain. But if you do manage it and the value of the pot goes up, so does the amount you can take out.

The income level isn't fixed like an annuity. It's recalculated at every review based on the age, value and gilt yield at the time. You are going to be able to take out more than you put in unless you die well before half of people do.

Withdrawing and market moves may reduce the value. It's just a regulatory warning that you need to pay attention.

If you want to get out as much as you can, start taking the maximum GAD amount every year as soon as you reach 55 and invest it outside a pension until you need it. You may not be able to get the value of the pot to drop for ten years, barring normal market ups and downs, but eventually you'll have taken out more than you paid in.

saintalan

Hardy7 wrote: »

These GAD rules seem to add another restriction on pensions. Essentially it looks like no matter how well your pension pot does or grows, you are never allowed to take more than the GAD limit each year....

Well you can if you use Flexible Drawdown.

You need to be receiving £20k in pensions to do so, if you are short of the £20k, you could always take an Annuity to make up the difference, then you can administer the rest to suit your needs.

zygurat789

You're not the only one taking money out of your DD fund, the management also require their cut, I saw some horrendous figures in the paper the other day.
Bear in mind that investments may and have gone down as well as up, reducing the value of your fund and hence the value of the % you are allowed to draw and the fund may be depleted long before you die.
With an annuity there is certaintity that you will receive the stated income, so long as the insurance co does not go bust.
There is a third option if you wish to leave a little something to your heirs you could not take an annuity and leave them the fund.

dunstonh

I saw some horrendous figures in the paper the other day.

Was that the usual media error of taking future money terms but displaying it in todays terms? I have yet to see one in the media shown correctly. They would then obviously look horrendous. However, they are wrong.

e.g. if you have a fund of £500,000 in 40 years time then a 1% charge would be £5000. However, that £5000 would have the spending power of something like £500 today.