Income drawdown vs annuity purchase at retirement

EdInvestor

wolverene wrote: »

I am concerned that my initial investment could disappear.

I'm not surprised. If you take out all the TFC and 5k p.a. you require an 8.3% return plus charges simply to remain at the same level - around 10% is probable. What are the charges on the drawdown? What is the investment profile for the money?

Very unlikely to get a 10% return in the current environment, though when the recovery starts this level of growth is quite possible, at least intially. But it's hard to sustain and you would need to be invested primarily in equities which heightens your risk.

How old are you? Can you wait for a while to draw the pension so the fund has some time to recover? Could you take the tax free cash and use that as income for a few years, for instance?

If you are youngish, locking into an annuity is not a good thing especially with a depleted fund.On the other hand I would judge the current proposal as pretty high risk and quite dubious unless you have other guaranteed income to cover at least your basic costs and preferably more than that.

wolverene

Thanks for the quick reply EdInvestor. I am 62 years old and have had to claim IB for the last 3 years after an accident. I`ve been told that the management fees will be about 1.5% and the fee to the IFA will be £1500.As to investment profile the IFA has said that the fund would be of a low risk asset group. I had worked out the same approx 10% performance as you but I question this performance in todays market.
My pension plan is with Sun Life of Canada and their offer annuity was a lot less than the Open Market. The biggest gripe I have with them is the time it takes to get my funds out, about a month, and when I first approached them for a quotation it took them 10 days to send the forms by which time I`d lost £14000 and been on a downward spiral ever since. As they dont supply actual pensions it means I have to accept an annuity thru them or transfer out to another provider to be able to get the 25% TFC, which is why I am looking around. Hopefully my existing pot doesnt go "to pot" in the meantime or when I finally get a transfer arranged.

EdInvestor

It is possible usually to switch your funds out of whatever they are invested in now and into a cash fund, which will stop further declines, without actually transferring out the whole pension.Not that you should necessarily do this now as it will prevent you from benefitiing from a market recovery, which may not be too far off now.

I'm surprised your IFA didn't tell you that. His drawdown proposal doesn't look very viable to me - though it might have worked before the fund value declined.

Is there any way you could use the tax free cash to live on for a couple of years until your state pension is nearly due to kick in, and leave the rest of the fund in drawdown at nil income to recover? if it recovers quickly (depending on markets) you could start drawing earlier of course.

It is often cheaper to do drawdown through the discount SIPP providers, eg
https://www.h-l.co.uk
https://www.sippdeal.co.uk

You might like to have a look around the sites.Note the costs of transfer in are much lower than your IFA's fee. You can obtain around 4% for cash in a SIPP drawdown at present; that might be a better temporary scenario than "low- risk" funds at Scot Life which after fees will probably return less than that and still open you to some risk.

If you want to invest in funds, then investment trusts (available in SIPPs but not at insurance cos) cost only 0.5% in charges, and there are plenty that pay decent dividend income in the 5-6% range. (IFAs are not however regulated to advise on them).A package of them, plus some of your fund in cash could be a low cost, lower risk longer term solution.

jamesd

wolverine, avoiding buying an annuity now after such a large drop in value is probably sensible, provided your ongoing investments have sufficiently risk that you can expect to recover the money during the next upturn. That means a reasonably similar equity proportion to what you started with. Dropping 32% suggests almost pure equity holdings.

What you might do is discuss with the IFA how to use enough equity to rover the capital during the upturn and how to gradually switch into a less volatile mixture over time during that upturn.

While you must take tax-free cash if you want it before you go into drawdown, it's also well worth putting that into investments so it also has the opportunity to recover its value.

Given the choice of taking income from the tax free cash portion or the part in drawdown, I'd go with the maximum possible from the part in drawdown. That will increase the proportion of your assets that can be taken as lump sums or arbitrarily high income, while the drawdown has limits on how high the income can be set.

wolverene

Tanks for the advice guys. Having lost so much of a pot due to the market falls I have been doing some figures and am very wary of putting the money left into anything risky. My IFA has said that "worst case scenario" would be 5% net if I put it into drawdown and pulling out £5000 pa. This sounds like pie in the sky as with that type of growth drawing down the full allowance would bring my pot down to £50k in 4 years if the markets dont do a big upturn. So it looks like I might go for an annuity and try and live a long time!! with a 10 year guarantee for the wife.
Oh to have a crystal ball .

jamesd

wolverine, I'm worried that you may not be a suitable person to use income drawdown. Here's why:

1. "I have a pension pot of £83000 ( it was £122000 back at the start of August but, as we all know, the market blew apart)".

This is a 32% drop, large enough to suggest that you had not changed the mixture of investments to reduce volatility even though retirement was approaching.

Did you originally plan to take the retirement money at 62 or are you doing it now due to the current market drop?

Not adjusting the mixture to reduce risk prior to a planned retirement or being panicked into taking the money out while the markets are during a downturn suggests that you'll make similar mistakes in the future and could seriously harm your future income if you use drawdown.

2. "the IFA has said that the fund would be of a low risk asset group" ... 'My IFA has said that "worst case scenario" would be 5% net if I put it into drawdown and pulling out £5000 pa. This sounds like pie in the sky as with that type of growth drawing down the full allowance would bring my pot down to £50k in 4 years if the markets dont do a big upturn'.

This suggests that you don't understand how investment risk/volatility varies between different types of investments and that you don't understand how the IFA expects you to get the income. This means that you're likely to choose unsuitable investments and also that you don't understand the product the IFA is suggesting sufficiently well for it to be wise for the IFA to sell it to you, due to the risks of a future mis-selling claim by you and of you losing substantial money due to investment decision mistakes by you.

I'll try to explain a little but your IFA should really be ensuring that you understand the risk of the investments and how you get the income before selling you the drawdown option.

Low risk investments include:

A. cash. This cannot fall in value faster than inflation unless the place the cash is held goes bust and the FSCS compensation limit has been exceeded. I expect that you would have at least a year's income in cash to reduce income variability, topped up from time to time, even though interest on cash is not what will produce most of the income. Cash has not fallen in value by 32%.

B. Government bonds - gilts. These can be held until their planned redemption date (the date the government pays the face value for them) and provide 100% certain payback on those dates (if you believe that the UK, like the US, will continue to be one of the two countries that has never defaulted on its bonds). Gilts are one of the investments purchased by insurance companies when someone buys an annuity, since they provide certainty that they will have the money to pay their future obligations, by buying gilts that will be redeemed by the government each year over the next 30 years. Holding gilts to redemption is lower risk than holding an annuity because the annuity insurance company could go bankrupt. Values of gilts have changed on the markets but not by 32% and it's irrelevant how much they vary day to day if you plan to hold them until redemption because the redemption value never changes. For the time until redemption they pay interest at the rate specified by the gilt. This income is part of what would generate the income the IFA expects, though the IFA probably isn't planning to use directly held gilts.

C. UK Gilt funds - unit trusts and OEICs. These are a combination of gilts with varying maturities and routinely change in value, though not by 32%, and pay the regular income from the gilts to whoever owns the fund units. This is typically one of the ways that low risk investment mixtures generate income.

D. AAA UK corporate bond funds. These are similar to gilts except that companies issue the bonds, not the government. The fund unit prices vary by more than gilt funds but not by 32%. Currently pries are very depressed, so quite high returns can be obtained. These pay interest and the interest is typically one of the ways that low risk investment mixtures generate income. Insurance companies that sell annuities typically put some of the money in directly held corporate bonds.

E. High yield, UK and/or global or "strategic" bond funds. Similar to gilts and corporate bonds but for companies with less certain futures. The uncertainty means that they pay a higher income but have more variation in day to day capital value. As with D, values are quite depressed at the moment and that's providing greater income than is usual for those buying today.

For the types A-E above you simply take the income. The part of fund value held in these things will not fall to 50k in four years because you aren't relying on selling any of them to take income, it's all coming form the interest paid by the bond issuers. The capital value is likely to increase as the world economy recovers.

F. UK equity income funds. These hold companies that pay dividends and the dividends are what provide most of the income, though long term there's also an expectation of capital growth to cover inflation and some of that capital growth can be taken as income if desired.

G. Property funds, held to get the income, not capital growth. Capital values have fallen a lot but rental income still gets paid out from funds that pay incomes. Tremendously reduced prices at the moment that may fall further but should eventually recover. The large recent value drops in what has historically been a quite stable investment mean that many strongly disfavour this class of investment at the moment.

H. Other UK funds. These tend not to pay much in the way of dividend income but are a necessary component to generate capital growth to cover the effect of inflation.

I. Global funds. These tend not to pay much income but are a necessary component for inflation protection.

A low risk set of investments will typically be mostly the various types of bond funds plus a large chunk of equity income and some of the others. It will typically not have enough in equity types to benefit greatly from a stock market recovery, accepting that for increased certainty.

Your IFA should be able to show you charts comparing the way the short term values of these investment types have varied over the last five to ten years so you can see that some move far more than others. Do note that the income is normally built in and does not depend much on how the capital value changes, whether it is up or down.

EdInvestor

I would certainly agree with jamesd that this is the right approach for drawdown - invest in a mix of assets which pay a stable income and keep a chunk in cash to top up to the max drawdown level (if that's what you are taking) as usually the income will be a bit lower, in the 5-6% range.

If you do it like this, the fluctuation of the capital value does not really matter, as your income will only be revalued every five years, and that's usually enough time for the fund to recover after a downturn.

But unfortunately, I doubt whether many IFAs have much idea about drawdown investment strategies, and certainly not ones which split capital and income.

Nor do they tend to have much idea about low cost strategies such as holding dividend paying shares or interest paying gilts directly, or investment in low cost investment trusts/exchange traded funds, simply because they are actually not authorised to make recommendations involving these products.

This means that a drawdown set up by an IFA is likely to be higher risk because its charges will be higher and its investment strategy sub-optimal.

wolverene

Thanks for all the comments,which have given me food for thought.

"This is a 32% drop, large enough to suggest that you had not changed the mixture of investments to reduce volatility even though retirement was approaching."

My pension plan is with a company who I had lodged a lump sum with of £37000 back in 1994. In 2001 they had to create a Redress plan ,due to mis-selling, of £12000. I had no input into what they were investing in other than being told that Equity funds were best. I am the first to admit that I have no idea when it comes to investing so left it to the "experts".

I had intended retiring at 65 but due to ill health ,and being in the position of having had to use up any savings I had just to keep on top of the bills, the Tax free portion I could take for early retirement looked useful.
It did not occur to me that I should tell the company that they should change what they had advised me- I was under the impression they would make these decisions being fund managers - complete virgin in this situation.

In the case of my IFA all I can say is that he estimates that the fund managers will aim to give me a return of 5% net and maintain my initial investment, as they have for others in the past. Hopefully there will be some good growth in the future but for the selection of assets I would have to be guided by him as I have no idea how to pick and choose.
This is my worry, `estimates` and `aim` are of course not guarantees.

Like many others all this is a complete minefield to me so this is why I now am tending to lean towards an Annuity but of course there are many of you who are more knowledeable who seem to advise against them.

EdInvestor

wolverene wrote: »

My pension plan is with a company who I had lodged a lump sum with of £37000 back in 1994. In 2001 they had to create a Redress plan ,due to mis-selling, of £12000. I had no input into what they were investing in other than being told that Equity funds were best. I am the first to admit that I have no idea when it comes to investing so left it to the "experts".

It is the job of you or your IFA to tell the company where to put your money.When you say you "lodged" a lump sum with the company and subsequently got redress, this means you were originally missold this pension.Who did the misselling?

It did not occur to me that I should tell the company that they should change what they had advised me

But was it them that "advised" you in the first place?.

I was under the impression they would make these decisions being fund managers.

The fund manager will run the fund. but it is up to you or your advisor to pick which fund(s) you want to put your money in and to change the arrangement if you later feel it is too risky.

In the case of my IFA all I can say is that he estimates that the fund managers will aim to give me a return of 5% net and maintain my initial investment, as they have for others in the past.

This is just nonsense and further evidence that you need a new and better IFA. Why would you bother to invest if this is what he thinks will happen.What do you take investment risk for? May as well put your money in the bank!

wolverene

"In the case of my IFA all I can say is that he estimates that the fund managers will aim to give me a return of 5% net and maintain my initial investment, as they have for others in the past".

What I omitted to say is the IFA stated the above as a "worst case scenario" he also said that as the markets recovered there would be potential for good growth

"It is the job of you or your IFA to tell the company where to put your money.When you say you "lodged" a lump sum with the company and subsequently got redress, this means you were originally missold this pension.Who did the misselling?"

Sun Life of Canada and one of their agents advised me that Equity fund was the way to go as far as I can remember as I was not dealing with anybody else. As an agent of the company I would have thought that their management should have involved decision making as I did not have an Independant advisor but had signed up with them thru their Agent.

"The fund manager will run the fund. but it is up to you or your advisor to pick which fund(s) you want to put your money in and to change the arrangement if you later feel it is too risky"

So the person I have to rely on totally is the IFA so if it all goes "t***s up" its a case of better luck next time?