Income drawdown vs annuity purchase at retirement

Pal

I agree that with-profits and investment linked annuties are inappropriate for many people, although they might be appropriate in some cases.

I don't understand why you are ignoring index-linked annuities? I agree with your comments on inflation: it is a major uncontrollable risk factor for all retirees (longevity and health being the other ones).

With income drawdown, in order to guarantee an inflation linked income, you have to take investment risk. Despite my earlier questions, there has not yet been an example given of a low risk investment that guarantees returns in excess of 4.5% a year rising in line with inflation. You mention high yield stocks, which can form part of a good investment portfolio, but the income is no way guaranteed and neither is it linked to inflation.

An annuity may not be ideal if you are the greedy child of a parent with a large fund, but annuities are essentially a mix of corporate and government bonds (both of which you "recommend"), inflation linked income (if you are sensible enough to go for this) and most importantly, the longevity risk is pooled in the same way as any other insurance pools the risk of an adverse event happening. (In this case the "adverse" event is that you live longer than expected. ). Yes, there may be a cost to setting up an annuity, but it need be no different from the cost of obtain advice on which high yield shares to buy within a SIPP, and an annuity is a one-off cost that does not require periodic review.

The simple fact is that income drawdown is ideal for wealthy, investment orientated people who are willing or able to take risks with their money and/or those who do not expect to live very long in retirement. Index linked annuities are ideal for those who believe they will live a long time or do not wish to take the "risk" that they will outlive the value of their savings.

Pal

As an aside, I think that the annuity rules should be rewritten to force people to purchase index linked annuities up to a specific level (for example £20k a year). This should guarantee that the individual does not fall back on state benefits in the future.

Once that annuity has been purchased, individuals should be allowed to take the rest as cash. They can then do what they like with the money.

EdInvestor

Edit by Pal, boardguide.

Oh crap I've done it again!!!! I hit the edit button instead of the quote button and have overwritten Ed's post. My sincere apologies to Ed.
Just to highlight that there was nothing wrong with Ed's post (the content was rubbish but it didn't breach the site rules or anything. )

The following is what I can rescue from the original post below. If he wants to edit this back to it's original message that would be great.

EdInvestor's post:

Most people cannot afford index linked annuities of course, and they are also widely regarded as poor value, which is why I don't mention them.

The gold-plated 100% best retirement fund of course for the very rich only would be an income drawdown invested in index linked Government stock,safer than an annuity and you don't lose the capital.

EdInvestor

As an aside, I think that the annuity rules should be rewritten to force people to purchase index linked annuities up to a specific level (for example £20k a year).

You'll be telling us Pal how much this will cost, will you?

dunstonh

Most people cannot afford index linked annuities of course, and they are also widely regarded as poor value, which is why I don't mention them.

With an index linked annuity paying about the same starting rate as a savings account, that is not the fault of the annuity. Rather its the fault of the individual who didnt pay enough in.

Going down drawdown route is not going to increase their income in the early years.

People do tend to get lower risk in attitude as they get closer to retirement.

Pal

The gold-plated 100% best retirement fund of course for the very rich only would be an income drawdown invested in index linked Government stock,safer than an annuity and you don't lose the capital.

What is the current projected yield on index linked Government bonds? About 2.75%? So if the individual is drawing out 5-6% a year (rising with RPI) as you have suggested, they are eating into their capital each year, aren't they? They are protected if inflation takes off, but if it does not, they are using their children's precious capital.

It doesn't matter how much a £20k annuity would cost at the moment, as most people are not retiring now. They are saving for a future retirement when annuity rates are more likely than not to be higher than now. The main point is to ensure that people save enough in retirement and have enough of an income to avoid the state having to pay out for them. If they don't save enough to guarantee that they will not fall back on the state, then they don't get the flexibility to do drawdown with their pension pot. In order to compensate for this I would like to see additional tax advantages granted. For example NI relief on contributions, additional company tax credits in respect of contributions made to employee pensions and so on.

EdInvestor

Pal wrote:

It doesn't matter how much a £20k annuity would cost at the moment, as most people are not retiring now. The main point is to ensure that people save enough in retirement and have enough of an income to avoid the state having to pay out for them.

You're damn right it doesn't matter what a 20k index-linked annuity costs because virtually nobody ever buys one.

But just so you know, it will cost approximately half a million poundsto provide a man aged 65 and his wife 62 with 20k pa for his life, followed by half that for his widow, index-linked to the RPI.

The average pension pot by contrast is about 35-40k, so even assuming people have two of them, they will only be able to provide about a quarter of that themselves, if you're lucky.

Statistics like these also make it pretty obvious why final salary company pensions are going rapidly down the drain and why civil servants are going to have to make do with less when they retire.

It is time IMHO that everyone got real.

Pal

So because they are relatively "expensive" at current annuity rates makes them a bad deal does it? What about your female retiree who is going to live another 20 years? What is the inflation linking going to be worth to her? What about people who still have 20-30 years to go until they retire? Will inflation linking be important to them?

What will annuity rates be in 20 years time? How about 10 years? Next year?

What is inflation going to be in 20 years time? How about 10 years? Next year?

It was you who first suggested that index linking is important, but you have yet to demonstrate a way of achieving it outside of an annuity that does not involve either taking (and paying for) regular advice or taking risk on shares. You claim that drawdown avoids the need for people to touch their capital, and yet every example you give would result in them either reducing the real value of their incomes over time or reducing their capital.

I have nothing against income drawdown and SIPPs, but I do object to people proclaiming it as the perfect solution to everyone's problems, when all it does is entail more risk, more hands on management and more worry for those that choose to do it. Most pensioners do not want to be bothered with these things.

EdInvestor

I do object to people proclaiming it as the perfect solution to everyone's problems, when all it does is entail more risk, more hands on management and more worry for those that choose to do it. Most pensioners do not want to be bothered with these things.

I know they don't. But do they have a choice any longer? I never said income drawdown was a perfect solution or involves less risk. Some risk is unavoidable if poverty is to be avoided: the point is, people have to learn how to manage and minimise risk, because savings that would have been adequate to fund their retirement a few years ago are not going to be adequate now.

The problem is they have been lulled into a false sense of security by 50 years of generous final salary and With profits pensions, fuelled by a generation of rising stockmarkets.But these days are now over.

Industry folk who don't recognise that fact and lead people into making irrevocable decisions - such as buying unsuitable annuities which won't fund their retirement for more than a brief few years - are not doing anyone a service, quite the reverse.

I make no apologies for being realistic about the unpleasant facts: if that will make people think before it's too late, good, that's what's needed.To resolve the problem, firstly the facts have to be faced.

ReportInvestor

What is clear is that dh is the "perfect" financial adviser "on display" on a public website. He claims to give better value than any investor who knows his own mind and goes it alone.

If this is correct, IMHO this doesn't say a lot for the competitiveness of UK financial services. It illustrates the fundamental problem that we all face in pursuit of Money Saving Value when we seek to invest.