Income drawdown vs annuity purchase at retirement

solway_2

The drawdown rate will change from 120% of the Government Actuary rate to 100% of Government Actuary rate. This will obviously reduce the income that can be taken from a Income Drawdown Pension.

Lee_Martin wrote: »

There's no doubt this is an important issue and one that needs further investigation. I will be speaking with my clients about the matter and taking them through how it effects them and their pension provisions. If you have an IFA you should consult them about your individual circumstances.

cky33

I am in the process of deciding which one is best for me.I am 62 years old and now have just over £180k in 3 funds.
I`m a smoker and like a few goldies but think my health is ok but with slightly high collestoral levels my Doc says.
Any comments would be helpful.
Thanks
cky

dunstonh

cky33 wrote: »

I am in the process of deciding which one is best for me.I am 62 years old and now have just over £180k in 3 funds.
I`m a smoker and like a few goldies but think my health is ok but with slightly high collestoral levels my Doc says.
Any comments would be helpful.
Thanks
cky

A couple of lines on an internet forum are not going to help you decide between two very different options. Options that are nearly always swayed by personal circumstances and individual issues.

You need to give more than you have if you want any sensible discussion back on the options.

Loughton_Monkey

cky33 wrote: »

I am in the process of deciding which one is best for me.I am 62 years old and now have just over £180k in 3 funds.
I`m a smoker and like a few goldies but think my health is ok but with slightly high collestoral levels my Doc says.
Any comments would be helpful.
Thanks
cky

The only comments that can be helpful, are ones that clarify the 'chalk and cheese' between which you are deliberating. There is no right and no wrong. it is really a matter of choice.

Here is a simplified guide as to the difference:

1. Buy an annuity. Here, you give all the money to an Insurance Company. In return, they guarantee to pay you "£X" a month for the rest of your life. [You have several choices about level, or escalating, guaranteed or not for a number of years, and with/without a spouse element].

Under this option the Insurance Company will throw your money - along with everyone else's - into a mixture of investments. Almost exclusively this will be reasonably safe 'fixed interest' investments like bonds, yielding typically around 4% to 5%. They are able to 'tie up' money into long term investments like this, because they are investing for thousands of customers. They know the 'exact' pattern of when people die and they 'match' the investment terms to provide a cash flow that matches all their pension payment liabilities.

Because there are literally thousands of pensioners in the annuity 'pot', the Insurance Company can naturally allow the 'early/young death' customers to pay for the 'late/very old death' customers. It is no skin off their nose. In technical terms, this turns out to be a 'bad deal' if you die young, and a 'good deal' if you live a long time.

By definition, the annuitant does not live to discover the 'bad deal' - although his spouse and/or family may see it that way.

On top of all this, you must assume that the Insurance Company has set rates so that they make a reasonable profit on the whole deal.

2. Put your pension into drawdown. This is a totally different kettle of fish. The first thing to understand is that you are completely missing the concept of 'insurance'. In other words, if you live a long time, you are not getting the benefit of a 'subsidy' from those who die early. You are 'on your own'. The converse of this, though, is that if you do die early, then that cash remains in the pot and is not lost. It can be used by a spouse (penalty free) for her own ongoing drawdown (or annuity if preferred). If no spouse, it can go to other beneficiaries after tax.

Unlike the Insurance Company, an individual cannot (realistically) put the whole pot into long term 'safe' bonds (at 4% or 5%, say), because there is only one of you. The funds must be 'liquid' enough to encash enough each month to pay what you desire to draw down.

You are allowed to draw down whatever you want up to the 'GAD Limit'. This limit is usually not a million miles away from what you would have got if you had elected to buy an annuity. Meanwhile, the pot is invested in whatever instruments (within normal boundaries) you choose.

The implications of this are that (a) if you achieve, on balance, the same investment return as an Insurer, then you could reasonably be expected to continue drawing down until a little bit longer than average age. [although if fund managers are making profits equivalent to Insurance companies, then it would be roughly average age only]. (b) if, on the other hand, you achieve more investment returns, then you can continue to draw for longer than average age. Obviously, (c) if you fail to get as good returns, the money will run out even before average age [or just as likely, the GAD limit revaluations will force smaller withdrawals - but they might almost last to average age].

There is an almost 'knee jerk' reaction to say that historically, Stock Market returns generally over-achieve bond yields, and so drawdown is 'better'. OK, but not if you live to a grand old age, and you are carrying the 'risk' that your investments might not achieve more than long term bond yields. Those who would therefore suggest "Go into drawdown, and invest in bonds" are missing the point. Firstly, because of the need for liquidity, you won't get the same yields as the Insurer. Secondly, you are losing the free 'insurance' for longevity.

Irrespective of overall investment performance, let's just assume you are 100% confident of achieving superior performance over your retirement period. Fine, but the 'volatility' of equity investments will throw a 'wobbly' at you. It is impossible to avoid significant ups and downs - despite perhaps making an overall 6%/7% in the long run. But you need to be prepared for the 3 year compulsory valuation to [occasionally] dictate that for the next 3 years you must take a 'cut'. Maybe you can militate against this a bit by taking slightly more than you need in 'good' times and save it to make up for shortfalls.

As a corollary to this, it gives you the 'reverse' of £cost averaging. When investing £100 a month into a fund, you end up slightly 'outperforming' the fund itself since you are buying more units when they are 'cheap' and fewer units when they are 'expensive'. Pension drawdown is the reverse. You would naturally 'underperform' compared to the funds you used since you would cash a lot of units in the 'cheap' phase and only a few in the 'expensive' phase. We are only talking small money here, but it can add up.

So here's where you would tend to choose drawdown:

1. I am confident I can invest well.
2. I have other income/cash and can live with volatility of drawdown amount.
3. I do not feel that I will live a very long time, or if I do, I can live with a much reduced income after I have lived to average age.
4. I am anxious to leave cash in the pot for my spouse/children if I die early.

You would tend to pick annuity in these circumstances:

1. I really need to feel secure about getting a 'definite' amount every month - however long I live.
2. I am not a particularly good investor and/or can't quite be bothered with the 'work'. I think I'm too old - and have deteriorating capacity to invest wisely.
3. I really want the same (or 50%) certain income to go to my spouse if I die - for as long as she lives. [You can buy an annuity with 50% or 100% spouse pension].
4. I have no wife, or she has adequate pensions/means on her own, and I really don't care about any pension fund 'lost' if I die early.

jamesd

Loughton_Monkey wrote: »

So here's where you would tend to choose drawdown:

1. I am confident I can invest well.
2. I have other income/cash and can live with volatility of drawdown amount.
3. I do not feel that I will live a very long time, or if I do, I can live with a much reduced income after I have lived to average age.

Item 3 is not an accurate reason. You can at any time buy an annuity with any proportion of the pension pot and can do it at closer to the optimal age of around 75 if you start out in drawdown. You're also better able to take an income and manage inflation than with an annuity, which typically greatly reduces income and caps the inflation protection level if you choose inflation protection.

Also, as an individual you are not required to have as much invested in low return gilts as an insurance company, so you're better able to use investments that produce better results, and also able to use your individual flexibility to adjust income, something an insurance company cannot do in the amounts it has to pay out.

Loughton_Monkey wrote: »

You would tend to pick annuity in these circumstances:

1. I really need to feel secure about getting a 'definite' amount every month - however long I live.
2. I am not a particularly good investor and/or can't quite be bothered with the 'work'. I think I'm too old - and have deteriorating capacity to invest wisely.
3. I really want the same (or 50%) certain income to go to my spouse if I die - for as long as she lives. [You can buy an annuity with 50% or 100% spouse pension].

A pension pot in drawdown can be inherited 100% into the pension pot of a spouse or other person with no tax to pay. And without taking the substantial reduction in income that is involved in buying a dual life pension.

The reasons to use an annuity are:

A. Lack of familiarity with investments and a desire to avoid using a professional to manage them.
B. Low risk tolerance.
C. At an age (likely over 75) where the income from an annuity beats reasonably achievable investment returns, and with a willingness to accept the drop in income or inheritance that is involved when buying an annuity.
D. A lack of willingness to adjust living standards if legislative fiat (the recent large drops with minimal notice) reduces the income that can be taken or if poor investment returns reduce the capital long term and hence the income available long term.

System

So here's where you would tend to choose drawdown:

1. I am confident I can invest well.
2. I have other income/cash and can live with volatility of drawdown amount.
3. I do not feel that I will live a very long time, or if I do, I can live with a much reduced income after I have lived to average age.
4. I am anxious to leave cash in the pot for my spouse/children if I die early.


And possibly:

5. I have invested in prime commercial property and its current rental income alone would support a comfortable pension without ever needing to realise the asset. ?

racine

Interested to know some facts about a SIPP I have. If I go for drawdown can I still take a 25% lump either now or later? Also having commenced drawdown can I still pay into the fund?

dunstonh

If I go for drawdown can I still take a 25% lump either now or later?

If you go for standard drawdown you can only take it at the start. If you go for phased drawdown then you can take chunks over a period.

Also having commenced drawdown can I still pay into the fund?

Generically, yes you can. However, your product provider can may not accept it. There are those that will.

racine

dunstonh wrote: »

If you go for standard drawdown you can only take it at the start. If you go for phased drawdown then you can take chunks over a period.



Generically, yes you can. However, your product provider can may not accept it. There are those that will.

Thanks for that

jamesd

Phased drawdown can be done using normal drawdown rather than buying a special phased drawdown product. Just tell your current provider that you want to take benefits from only part of your pension pot. If they don't let you do it, move some to a place that does and have one in drawdown and one not. Repeat as required. You can pay into the one that you haven't taken benefits from. Or can open a new one if you prefer. Up to you.