drawdown v annuities

edited 30 November -1 at 1:00AM in Pensions, Annuities & Retirement Planning
4 replies 1.2K views
louisebeverley_15louisebeverley_15 Forumite
6 Posts
Can anyone advise me on which is the safest and best way for private pension schemes

Replies

  • edited 30 October 2014 at 9:49AM
    LintonLinton Forumite
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    edited 30 October 2014 at 9:49AM
    I can tell you the safest, but I cant tell you the best as that depends on your personal circumstances and psychology.

    Assumptions

    1) The purpose of a pension is to provide income for your old age, not to provide an inheritance after your departure
    2) "Safety" means that you continue to receive an income no matter how long you live (you never run out of money) and your income is never reduced by inflation.

    The Safest

    There is only one product that can provide as near as possible absolute safety - an index linked annuity. This is effectively guaranteed by the UK government and would only fail in cataclysmic circumstances.

    Why doesnt everyone go for index linked annuities?

    1) They are very expensive. To buy one you need a lump sum of over 30 times your desired income.

    2) You lose the lump sum - if you happen to die early there is nothing for the grieving relatives. If you die late you win, being subsidised by those who die early. Any annuity is an insurance policy against living too long.

    Other options?

    1) Fixed rate annuity

    +++: You get more than twice the income for your pension pot.
    : Inflation could seriously erode the value of your income leaving you in absolute poverty in your very old age.

    2) Drawdown

    +++: Flexibility, you can take what you want when you want it
    +++: Any money remaining when you die goes to your beneficiaries
    +++: You are in control
    +++: Opportunity for higher returns than an index linked annuity

    : You are in control, poor decisions can leave you in poverty
    : Risk - nothing is guaranteed
    : Lower sustainable income than with a fixed rate annuity. You take the risk that you live too long rather than the insurance company

    Best?
    A mixture to provide the optimum combination of income, safety and money for beneficiaries at a price you can afford and a degree of risk that you can live with. So it depends very much on your circumstances.
  • atushatush Forumite
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    I answered your other thread, you should really only have one? Delete one?
  • BootsoxBootsox Forumite
    171 Posts
    Linton wrote: »
    ...Inflation could seriously erode the value of your income leaving you in absolute poverty in your very old age..
    I know where you are coming from but absolute poverty is pretty serious stuff, less than a dollar a day?
  • edited 31 October 2014 at 11:25AM
    jamesdjamesd Forumite
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    edited 31 October 2014 at 11:25AM
    Safest depends what you want the money to be safe from.

    With an annuity you get a guarantee that there is no inheritance value, so it is a 100% inheritance loss, aside from guarantee periods of a few years that you can buy. The income is pretty much guaranteed, with very low chances of failure and good protection even if the annuity firm goes bust. But the income level is fixed for the age at which you buy and you can't change the annuity type later, say if you get less healthy in a way that would allow you to buy an annuity that pays more. Level annuities are most common, something around 90% of all annuities purchased. The Pound amount paid by these never changes and inflation will gradually reduce the buying power of them, possibly rapidly if inflation becomes high. RPI inflation-linked annuities are safe from this risk but pay out much less at the start.

    If you are going to reach your state pension age before April 2016 you will have one excellent option that beats annuities thoroughly for those in normal good health: you can defer taking your state pension and it will increase by 10.4% for each year, pro-rated for parts of a year. Don't even think of an annuity if you're in good health until you've done this, it's a far, far better deal. Deferring for 3-5 years at least is likely to work well for women, longer can, it's just less sure. So you'd defer and spend the pension pot to live on while deferring. Then you get the very safe state pension money for life, however long your life is.

    With drawdown instead, the money that you do not use for living expenses is available for inheritance. You have to deal with the ups and downs of whatever investments you buy and may need to reduce the income if they don't do as well as usual, or could increase it if they do better. If your life expectancy changes due to less good health you can increase the income you take. Same if you find you need to use a care home, you can increase income to cover that knowing that life expectancy tends to drop a lot at that point, and/or you can by a relatively efficient annuity specially intended to pay for care home fees at this point. A commonly mentioned rule of thumb for drawdown is that you can safely take about 4% of the starting value and have that increase with inflation as your income. But you must be willing to change that if there is a sustained drop in investment values.

    You can also use a mixture of these things. You can do things like drawdown with gradual buying of annuity once you start to get to the age 75-85, where they tend to become a lot more efficient for those who have normal life expectancy.

    Ultimately this is about what you want to be safe from and what risks you want to cover, plus how important inheritance and dealing with life's challenges are to you. There's no one perfect solution for everything.

    One approach that can work well is combining the state pension plus annuity or state pension with deferral to provide your basic minimum income level that you absolutely have to have. Food, utilities and a place to live and little else, say. Then the ups and downs of investments won't matter so much because you'll have a secure base.
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