Income drawdown vs annuity purchase at retirement

bendix

Fascinating discussion, and one I've learnt much from over the last couple of days.

To me this is a philosophical discussion - about one's ability to accept risk and responsibility for one's own financial wellbeing.

I simply can't fathom why anyone would think an annuity is a better option, when you are basically giving up your entire pension pot when you die. To those who say USPs are risky - well what about the risk of buying an annuity at 75, getting some terrible return from it for two years and then you die? What a strange thought.

As a mature responsible adult with my own self-interest at heart, I want to retain control over my own fortunes for as long as possible. And I definitely want my nest egg to be passed onto my estate. Anything else is completely unacceptable.

dunstonh

I simply can't fathom why anyone would think an annuity is a better option

Just ask all those that have lost money on income drawdown.

To those who say USPs are risky

Which is just about everyone who knows how they work.

well what about the risk of buying an annuity at 75, getting some terrible return from it for two years and then you die? What a strange thought.

The annuity rate at 75 is going to be very high. If you die what do you care. You are dead.

To assume that you could not end up financially worse off is just like assuming property prices always go up. If you accept the risk and the advantages of drawdown exceed the negatives and you can afford to take risks with your retirement income then its a good option. If you cannot afford to take risks with your retirement income then it would be a high risk transaction which could see you suffering significantly in the future.

bendix

Sure I can lose money on USPs, but there are two responses to that. Firstly, the losses will be MY FAULT and with my completely understanding the risks involved in using the money that I have saved over the years. It's called personal responsibility.

But surely the key argument about 'losing' money is that when I purchase that annuity, that money is completely lost to the insurance company.

I give them 200,000 pounds. They give me a trifling 10-12,000 a year back (returns that are pretty conservative and accessible for a normal savings account), and yet I've lost ALL that 200,000 to the insurance company.

As for not caring when I die . . . . ummmmmm, what about my dependents? I'd rather take the risk, be personally responsible AND have something to leave my estate.

You talk about risk, but surely the risk (might go up, might go down) is better than the CERTAINTY of getting a !!!!poor return on an annuity (based on current figures) PLUS the certainty of giving your entire nest egg away?

Or am I missing something here?

dunstonh

But surely the key argument about 'losing' money is that when I purchase that annuity, that money is completely lost to the insurance company.

Only when you die or your spouse dies (if joint annuity) and you havent bought capital buy back. However, it guarantees an income for life.

I give them 200,000 pounds. They give me a trifling 10-12,000 a year back (returns that are pretty conservative and accessible for a normal savings account)

7.76% for non smokers at 65. Higher for smokers or those on medication. Guaranteed for life. Name a savings account that does that.

As for not caring when I die . . . . ummmmmm, what about my dependents?

If you are willing to compromise your own retirement to benefit your children then its your choice.

You talk about risk, but surely the risk (might go up, might go down) is better than the CERTAINTY of getting a !!!!poor return on an annuity (based on current figures) PLUS the certainty of giving your entire nest egg away?

Or am I missing something here?

Yes you are missing something. You are focusing on all the benefits of drawdown and not the negatives. You must look at the potential negatives and see how they would impact your situation if they were to occur. If they will have little or no impact then thats fine. However, if they have a significant impact then you are taking a massive risk.

I personally will do income drawdown. However, professionally I do more annuity purchases than drawdowns because most people are not accepting of the risks or are not in a financial position to accept risks with their only source of income in retirement (apart from state).

bendix

All good points, my friend. And thanks for raising them. 7.76% is a decent return and few savings accounts will give you that, I agree. Conversely, few savings accounts will insist on treating the original capital as a very generous gift, so I guess that evens it out a little.

And that - for me - is the most important point. I'm not going to spend years building a decent nest egg, only to give it to a faceless insurance company.

If the alternative is accepting a riskier return (which may be lower or may be higher and i go into it knowing those risks and accepting them as a rational being capable and willing to determine my own destiny) and I get the chance to pass on those savings to my kids, then it's a no-brainer. Of COURSE I'm going to compromise my retirement for the future well-being of my loved ones - isnt that the whole point of having loved ones?

Anyway, it's an interesting debate and I've learned a lot but I know intuitively where I sit on the issue. And, in my case, the pension pot will be only a small portion of my nest-egg. I have overseas funds and property to supplement my income.

EdInvestor

The other big problem with level annuities is that in addition to losing the capital, over a long retirement the income loses value due to inflation.Even at very low rates like 3% after 20 years, your income will be worth only half what you started with.

Annuities worked well when life expectancy was low and people died 10 years after retiring, but now they live much longer and the annuity guarantee is worth a lot less than it was. At the same time, guaranteed inflation linked income from sources like state pensions is on the rise.

Most people are prepared to take a risk with their capital so as to match or beat inflation, as long as the basics are covered by safe and rising income. Hence drawdown is now getting more popular (21% of retirees choosing it over annuities now, against a negligible number 10 years ago).

That trend is likely to increase partly because more people are being switched out of final salary into money purchase pensions and thus becoming more accustomed to taking risks, and retirees income rises, as more women have their own higher pensions. Loosening regulations, higher pensioner tax allowances and new products (such as "half way house variable annuities) may also play a role.

jamesd

dunstonh wrote: »

7.76% for non smokers at 65. Higher for smokers or those on medication. Guaranteed for life. Name a savings account that does that.

For comparison here's a table showing the required interest rates or investment returns to just run out of money when you die for various death ages when drawing 7.76% income, ignoring inflation so it's comparable with the level annuity dunstonh used. Anyone retiring now should count on living to age 90 at least, since that's roughly the age that half of people aged 65 today will live to.

Die aged Interest rate to just die broke, drawing 7.76%
70	-18.3%
75	-2.55%
80	2.67%
85	4.94%
90	6.09%
95	6.73%
100	7.1%
105	7.33%
110	7.48%
115	7.57%
120	7.63%

Since this is partly about risk management, here's the chance of equities achieving various investment returns over a 20 year period, after inflation (page 197 of Pensions Commission Report, itself using the 2005 Barclays Equity Gilt Study data):

-2- -4%	1%
0- -2%:	1%
0-2%:	12%
2-4%:	15%
4-6%:	19%
6-8%:	20%
8-10%:	9%
10-12%:	7%
12-14%:	2%

The average and median return after inflation is 5.5%. That would be enough to not run out of money at any likely life expectancy but at 2% inflation it wouldn't be enough to do it while taking 7.76% income during 30% or more of the 20 year periods in the last hundred years. You use gilts, corporate bonds, non-UK and other investments to reduce the chance of failing to meet the target. And adjust income if necessary during bad time - which requires a sufficiently high income so you can afford to do that.

The variability of returns shows why the state pensions and possibly using some of the pension pot to buy one or more annuities can have value in reducing the chance of seeing unacceptably bad results.

bendix

Having been out of the UK for (effectively) the last fifteen years I've never given this much thought. It's only now that I'm contemplating returning for a few years that I've been forced to think about these things.

And the thing that strikes me is the patronising and criminal approach of not allowing adult human beings to decide what is best for them in their retirement. The idea of a government forcing you to hand over your pension pot to an insurance company in return for some paltry return (which most of us could beat as amateur investors) and then losing those funds is scandalous.

What are we? Sheep? Children who can't be trusted to look after ourselves?

What other country forces annuities onto people?

Outside in the real world the world runs by such ideas as individual responsibility, caveat emptor etc. And, frankly, it's better for it.

Paul_Herring

bendix wrote: »

And the thing that strikes me is the patronising and criminal approach of not allowing adult human beings to decide what is best for them in their retirement. The idea of a government forcing you to hand over your pension pot to an insurance company in return for some paltry return (which most of us could beat as amateur investors) and then losing those funds is scandalous.

What are we? Sheep? Children who can't be trusted to look after ourselves?

Since you ask, yes. The vast majority of people in this country cannot be trusted to look after themselves in retirement.

jamesd

bendix, nothing forces people to take the tax relief and accept the restrictions in return. Those who don't want them can use ISAs or invest outside any tax wrapper. At the moment it's entirely possible to take pension income without buying an annuity.

If you want to avoid or delay paying the tax you have to play by the government rules for getting that tax break.