Income drawdown vs annuity purchase at retirement

oceanblue_3

Deemy, there is no way that you could achieve that level of return from Index-Linked Government Stock. Although all the recent issuance has been 2% or 2.5% plus inflation, it has often raised over twice the face value for the longer terms.
Effectively, you're paying £200.00 or so for a stock that generates up to £45.00 per year, index-linked - that's a yield of 2.25%, not 4.5%.

EdInvestor

Pal

As you know, the way successful income drawdown plans work is by investing in assets which produce a yield - a dividend, an interest rate, whatever and then matching the income to the yield, allowing the capital to grow.To obtain the rising income a percentage of the fund would be invested in assets which tend to rise in value over time and produce rising yields.

This will produce volatility on the capital side, but this need not necessarily be a major concern. The inflation risk is IMHO much more serious than capital volatility over a woman's 30 year retirement. What is important in retirement is stability on the yield (the income) side, and preferably a rising yield.Even with a big stockmarket crash like the one 5 years ago,many portfolios will now have completely recovered, with no damage at all from the volatility and a stable income throughout.

The types of investment which produce stable and rising income are blue chip companies with the relevant dividend policy, commercial property funds, some corporate bond funds ( though you must be careful with funds as the charges can eat heavily into returns.)

An appropriate mix of these would be combined with cash, exactly how would be different for every portfolio according to the state of the various markets at the time and other criteria, including what the investor is comfortable with.[Women it is said, are often more comfortable with long term buy and hold equity investing that men, who are either too impatient, or too nervous about volatility.]

The investor gets to keep the capital, and hopefully pass it on to heirs later: and for many investors the ability to do this (not available with an annuity) will also provide an additional element of security: the flexibility to use his home to generate extra income ( eg via equity release) if necessary, without feeling guilty about children's inheritance.

That's an important safety factor.

oceanblue_3

Quote from Editor/Edinvestor........"Even with a big stockmarket crash like the one 5 years ago,many portfolios will now have completely recovered, with no damage at all from the volatility and a stable income throughout."

I know I've said this before but, perhaps, it's worth repeating.........Editor/Edinvestor, your glib pronouncements are very dangerous. This generalisation of yours is completely misleading and, I suspect, demonstrates your lack of experience in actually advising real people, face-to-face.

1) Many investors who commenced drawdown contracts 5 years ago are still nursing substantial losses; these losses have prompted their drawdown providers to reduce their incomes. Don't forget: the individual investor does not have complete control over the amount of income s/he receives.

2) The FSA would always class these contracts as being more suitable for those customers whose tolerance of risk is above average. For you to describe them in the way that you do is grossly unfair. You are a loose cannon on a rolling deck, and I wish you would learn to control your irresponsible exuberance.

3) Do not follow Editor/Edinvestor's suggestions just because he sounds confident and breezy - he is not responsible for your actions [YOU ARE!], and I believe he is simply attempting to promote his own website.

EdInvestor

There are many people who believe annuities are the wrong product.

Here's some research on the issue

Readers should be aware that income drawdown is the normal way people finance retirment in most comparable countries, like the US,Canada and Australia. Annuities are only of minority interest for a part of a pension fund. This is because of the inflation risk, especially for women. The paper above suggests that a woman retiring at around 60 should have 60% of her fund in equities.

Many investors who commenced drawdown contracts 5 years ago are still nursing substantial losses; these losses have prompted their drawdown providers to reduce their incomes. Don't forget: the individual investor does not have complete control over the amount of income s/he receives.

Let me explain a little for those who aren't familiar with the way drawdown works. Drawdown plans contain safeguards to stop inexperienced investors - or incompetent IFAs - from losing all the money in the fund through unwise investments or unexpected crashes .

There are limits to the amount of money you can take out. But unlike level annuities, the income from drawdown is flexible within the top and bottom limits which are set according to gilt rates, and the top limit is significantly higher than comparable annuity rates.

Thus, if we take a 55 year old woman with a 100k pension fund, under drawdown she would be able to take an annual income of 7,000 quid, compared with the best current rate of 5,640 if she spent all her capital on an annuity. A 60 year-old woman could take 7,800 from her drawdown plan, compared with 6,078 from a level annuity.

There's a second safeguard: every 3 years the provider is required to check the state of the fund and adjust the income limits to take account of whether it has got bigger or smaller. Let's say our 55 year old woman's fund is now 20% smaller because of losses in the stockmarket crash, so her limit should be cut so she doesn't run out of money. But she's also 3 years older, so her income limit for the next 3 years would adjusted upwards. Overall it would work out at 5,920 for the next three years.That's a reduction on the original 7,000, but it's still higher than the 5,640 that she would have got from the annuity.And meanwhile her fund will be increasing again as the stockmarket recovers, so at the next review she can probably expect an upwards income revision.

Similarly for our 60 year old, her 20% fund loss will translate into an income reduction to 6,720, still higher than the 6078 she would have been getting from the annuity (and she's already 5,100 better off in income terms over the three years if she's taken the max from the drawdown).

Now this assumes that our drawdowners are taking the full amount from their fund.But many may not need to do this: rather they may prefer to match their income more closely to the yield on their investments.So if they establish an investment package consisting perhaps of shares paying an overall dividend yield of 5-6%, property funds payng 6%, corp bonds 6-7%similar and gilts/ cash of around 4%, then they can take an income of around 5.5% and leave the capital entirely alone to grow for later.

For our 60 year woman, that would be a reduction of less than 500 pounds annually on the starting income for a level annuity (and much higher than an index linked annuity), for our 55 year old the difference is minimal.Not accessing the capital should allow it to grow in future, thus increasing the fund size and the drawdown income top limit, providing inflation protection.

As the fund grows and the drawdowner gets older the fund grows and more of the larger capital can also be taken as income if required. By contrast,the fixed income annuitant has no capital,no flexibility and the value of her pension is falling every year.

Income drawdown does require some attention and needs to be done through a low cost provider to be sure of success. It won't suit everyone in the UK, one of the few countries which have a long history of compulsory annuitisation. But as I've said, in other countries it's the norm, and for people retiring young with 30 years ahead of them, it's considerably less of a risk than an annuity IMHO because of the inflation aspect.

Of course anyone who elects to try drawdown and finds they don't like it can convert their fund to an annuity any time.

oceanblue_3

"Thus, if we take a 55 year old woman with a 100k pension fund, under drawdown she would be able to take an annual income of 7,000 quid, compared with the best current rate of 5,640 if she spent all her capital on an annuity. A 60 year-old woman could take 7,800 from her drawdown plan, compared with 6,078 from a level annuity."

Edinvestor, have you ever actually advised on drawdown? The reason I ask is that the figures quoted above bear no resemblance to those I have recently obtained from the Government Actuary's Department website.
I should be most grateful if you would show your workings........

whiteflag_3

As of next year you won't have to buy an annuity.Instead you can keep the fund invested and take an income from it when you retire.This is called "income drawdown".

Edinvestor demonstrates his basic lack of knowledge on this area in the opening line of this thread. Why do you have to wait until next year to do income drawdown?

EdInvestor

Hello OB

The figs are from Billy Burrows's site.

http://www.williamburrows.com/ar/rates.asp

Whiteflag: for simplicity's sake I thought it easier on the other thread not to go into the question of "alternatively secured income" for post aged 75 drawdown.The whole thing is unnecessarily complicated as it is :rolleyes:

oceanblue_3

Edinvestor, advisers are obliged to refer to the Government Actuary's Department website

http://www.gad.gov.uk/Publications/docs/NonProtRightsInstructsTables_9May2005.pdf

not to the website that you have mentioned. Do you know what you're talking about?

The website that you have referred to won't be able to quote maximum incomes in any meaningful sense, and their gilt yield figures may well be out of date.

If you really know what you're talking about, use the information I have provided to calculate a 55-year-old woman's maximum income under drawdown. Let's see if it's £7,000.00.

While we're on the subject.......can you guarantee that annuity rates will improve for this particular person between ages 55 and 58? Age is not the only important factor to affect gilt yields.

dunstonh

With regards to rates, I believe the comments referred to the drawdown income figures you quoted rather than the annuity rates. That site does say drawdown is high risk.

EdInvestor

I must say it's heartwarming to see this outpouring of concern from financial services industry personnel determined to prevent any suggestion that might expose unwary and ignorant punters out there to undue risk.

So very unusual.

Do keep it up!