Income drawdown vs annuity purchase at retirement

jamesd

After reading your reply I telephoned the FOS to get a definitive answer. The call was routed to Jim in the complaints section who did some checking and informed me that drawdown questions would not be included in the personal pension or other sections but were all consolidated into the number on the income drawdown row.

dunstonh

jamesd wrote: »

After reading your reply I telephoned the FOS to get a definitive answer. The call was routed to Jim in the complaints section who did some checking and informed me that drawdown questions would not be included in the personal pension or other sections but were all consolidated into the number on the income drawdown row.

Interesting. That does beg the question then why did the FOS raise it as a concern and why are compliance companies and PI insurers highlighting it as such an issue when it has a tiny number of complaints at the FOS.

jamesd

Perhaps because of the very rapid growth of drawdown and the desirability of encouraging people to give good cautions about risk to try to avoid a greater growth in cases. If I recall correctly I've seen suggestions that as many as 50% of potential annuitants are choosing drawdown instead at the moment, though I don't remember if that was advised cases only or not.

It's particularly understandable that PI insurers would want to highlight potential issues in an area with very rapid growth and not yet well characterised risks for them.

Given the period covered by the report and what the markets have done during that period it's quite an interesting result. Perhaps a lot of people are bond-heavy as might be expected for drawdown and have seen capital gains or neutral results rather than losses. If so that might produce an increase in complaints when yields of gilts and high quality bonds increase and customers start to complain about being told they were safe.

RichardColl

What would you consider to be a reasonable growth ratefor you Pension Plan (that’s Yield + the increase in share prices) for areasonably conservative and well spread portfolio, over the long term.

If you are looking at the predicted averagelife expectancy in retirement for someone aged 65 retiring today, this mightmean the next 30 years!

Suppose you said 6% per annum. Well, the Governmentcurrently allows a GAD rate of 5.6% for income drawdown schemes which meansover those 35 years your pension plan would gradually grow in value leaving alarger sum when you die than you have right now, even after allowing for thepaltry age-related increases in the GAD rate. Do the sums assuming a totalreturn of 8% (not unheard of by any means) and your pension will be worthseveral times its current value, even at today’s values.

So, you leave this sum to your dependents, if you haveany; but if you do that a whopping 55% goes in taxes leaving just 45% to thosedependents. But don’t you want to have the use of these funds for yourretirement. A recent survey conducted by RetireEasy.co.uk showed that mostpeople in or facing retirement want do just that.

Also the gilt yields are on the floor mainly due theGovernment’s QE policies so at a time when the Government is itself forcingdown annuity rates and GAD rates what does it do – it changes the rules so youcan only take 100% of GAD rather than 120%. This is bizarre policy as forcingretirees to take a lower income reduces the tax revenue for the Government

Yet, the Government needed to raise tax revenue fromretirees by removing the age-related tax free allowances so has the Government.

jamesd

You're making a little mistake there. Gilt rates are likely to rise again and take the amount that can be taken out higher. At a 2.5% gilt yield it's 5.3% at age 65 but if gilts go back to their more usual sort of level of 4.5% or so that would be 7% instead.

The plan doesn't grow for 35 years unless you can increase the investment returns or choose not to take out the maximum. This is because the GAD lmit increases as you get older. It's 5.6% now (7% at 4.5% gilt yield) at 65 but at 75 it's now 8% (9.3% at 4.5% gilt yield).

Just 20 years on and you get to the 85 and older limits, at 14.3% (15.8% at 4.5%). That'll go some way to letting you take out any accumulated capital from the earlier years.

You can of course play the numbers by using a mortgage, assuming you can meet the lending conditions. That can let you use mortgage capital to spend more at lower ages, then repay it at older ones. Which is one of the methods you can use to provide a smooth income level without drawing down capital from non-pension investments other than the house.

Linton

The other mistake you are making is basing your comparison on equity returns. The objective of an annuity is to guarantee a steady income absolutely. The GAD rules are designed to ensure that drawdown would normally meet the same objective. The only way to provide a absolutely guaranteed investment in so far that is possible is with government backing - ie gilts.

The danger with basing your planning on average return is that by taking a steady income you are very badly hit in the economic down turns. To see the effect of taking too much steady income from an equity investment have a look at firecalc.

In practice the GAD limit isnt too bad as by investing in equities you can get an income which approximately matches inflation of a similar size to a fixed income from an annuity.

If you have a guaranteed income from other sources of £20K then there are no drawdown limits as even if you lost the whole pot you would still have enough income to live on.

Supernova

Hi,

If I had a pension fund of £400K at age 55 in a year's time, what typically would be a way of structuring it and maximising income from it using income drawdown, whilst leaving it open for future contributions?

How much could that income be and are there other SIPP companies worth looking at other than, say, Hargreaves Lansdown?

Thanks for any initial thoughts

Aegis

Supernova wrote: »

Hi,

If I had a pension fund of £400K at age 55 in a year's time, what typically would be a way of structuring it and maximising income from it using income drawdown, whilst leaving it open for future contributions?

How much could that income be and are there other SIPP companies worth looking at other than, say, Hargreaves Lansdown?

Thanks for any initial thoughts

You might consider keeping the majority of the pension uncrystallised and using a phased drawdown strategy to take a proportion of pension commencement lump sum with a little taxable income periodically. That will maximise the amount of your scheme still uncrystallised, to which you can add more as time passes and you find yourself with greater earnings.

The downside of this is that it's complicated and can be expensive to implement with the wrong provider. In addition, if you aggressively draw down on your pension fund early, you may leave yourself without sufficient income later in your retirement.

jamesd

Supernova, you can't have the same "arrangement" both in drawdown and taking new contributions but it's possible to have one arrangement in drawdown and one not, both with the same pension provider. They may not even mention that arrangement word, just say you can have part in drawdown and part not.

The GAD table here shows the income limits using the current 100% rule, but that'll probably go back up to 120% by the time you take it, so add 20% to the maximum. Assume that the gilt yield will be 2.5% in a year, should rise gradually over the subsequent years as economic recovery happens, back to a more normal 4.5% to 5% eventually. So at 2.5% that means £13,800 of income from £300,000 in the pension pot plus about a third of that outside the pension and gradually being moved into ISA investments. Maybe £18,400 total before tax income. You can draw on the non-pension part faster if you like, say to provide a higher income level until the state pensions can start.

If your objective is income you can maximise that by recycling the lump sum gradually into new pension contributions, within the HMRC limits for that. The easy one is 1% of the lifetime allowance, so £15,000 in one year and you could borrow money to do that this year if you like and are within the £50,000 a year and PAYE/earned income limit as well, so you get tax relief on it all. If you might do that in later years, read the limits on recycling to be sure you're complying with them.

You might look at the James Hay offering, but the market is currently in flux so it's really hard to say what will look best a year from now. HL is convenient enough and not too bad as a transient place while the dust settles. But with £400k or £300k after taking out the maximum lump sum, you can definitely save money in other places, perhaps £750 a year if not getting ongoing investment advice (assumes an extra 0.25% commission saved compared to HL).

Supernova

Thanks Aegis and jamesd for those replies. I will digest and revert :-)