Income drawdown vs annuity purchase at retirement

kidmugsy

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

If it's "capped drawdown" yes.
If it's "flexible drawdown" no.

racine

Presumably I can start a new fund? If so can I claim tax relief on this new fund?...as far as I can see I can't on a capped fund

kidmugsy wrote: »

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

If it's "capped drawdown" yes.
If it's "flexible drawdown" no.

jamesd

Previously there was just drawdown. There's pending legislation that changes it into two types, capped, which is just like the old one but with lower income limits, and flexible, available only to those with £20,000 or annuity, work or state pension income, that allows unlimited income. Once someone chooses flexible they can never again get tax relief on pension contributions, whatever pension pot they want to pay into.

Yes, you can start a new fund. We're all allowed to have an unlimited number of pension pots, with as many different companies as we like.

cky33

Thanks very much for your indepth comments.I have now got an IFA working on the subject but feel I have a better understanding thanks to yourself. Cheers CKY33.:)

Loughton_Monkey wrote: »

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.

PyttsPete_2

Can anyone confirm the lower limit of (I think) £50,000 to be able to claim an income drawdown pension? By that I mean that you must have a pension pot of at least £50,000 to be allowed to take an income drawdown scheme, investing in equities rather than annuities. And unless you do have the requisite sun you are lumbered with annuities only which expire when you do? Thanks

Paul_Herring

PyttsPete wrote: »

Can anyone confirm the lower limit of (I think) £50,000 to be able to claim an income drawdown pension?

Are you thinking of the ₤20,000 limit after which you can have flexible drawdown?

http://www.moneymarketing.co.uk/pensions/treasury-sets-mir-for-flexible-drawdown-at-%C2%A320000/1023377.article

Under that, you can still use drawdown, but it's not as flexible. (Known as capped, because what you can withdraw is capped to what you'd get if you were to purchase an annuity.)

[Think I got all that right - DH or another will be along to correct me if I'm wrong.]

dunstonh

Can anyone confirm the lower limit of (I think) £50,000 to be able to claim an income drawdown pension?

capped drawdown can be as low as £3600 (I dont know any that will go lower than that).

PH has covered the points on flexible drawdown. That is [secure] income based rather than fund based.

PyttsPete_2

Thanks for this but I may not have expressed myself well. I have a very small pension pot of some £28k, the rest being property investments. I would like to take the 25% tax free lump sum and the rest will have to be invested. My provider (Aegon) has advised me that the balance has to be invested in annuities as there is a de minimus rule that prevents a sum less than £50,000 being invested in equities. This would alsdo mean that when I die there will be nothing left for my family. So I am really checking to see if that advice is correct. Thanks

Paul_Herring

PyttsPete wrote: »

My provider (Aegon) has advised me that the balance has to be invested in annuities as there is a de minimus rule that prevents a sum less than £50,000 being invested in equities.

There is no government stated minimum, however the pension companies themselves typically mandate an absolute minimum that they will take in order to purchase an annuity (otherwise it's not worth their while.)

A 2007 Telegraph article suggests it was around ₤10,000 back then, though the key to one best buy table I found suggests there are firms out there that will go as low as ₤5K or even ₤1K.

As to the absolute requirement to buy an annuity with the remainder after a lump sum, I don't know - see what DH has to say...

dunstonh

My provider (Aegon) has advised me that the balance has to be invested in annuities as there is a de minimus rule that prevents a sum less than £50,000 being invested in equities.

What they actually mean is their own product has that rule. There is no HMRC/FSA rule.

So I am really checking to see if that advice is correct.

Aegon dont give advice. They only tell you what their product does.