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Drawdown v annuities: which pension strategy wins?
Saving enough to live the lifestyle you want in retirement is a daunting task, but employing a combination of strategies can help.
by Michelle McGagh on Jun 07, 2012 at 11:02
Going into retirement has traditionally meant using your pension pot to buy an income with just with one financial product, known as an annuity. But as pensioners struggle to make the most of their savings, some experts believe you may need to look at combining different financial products to help you maintain the lifestyle you want.
An annuity is an insurance contract that will provide you with an annual income based on your age and how long the insurance company expects you to live. However, it is also based on a number of other factors that have been restricting the amount of money you can expect to get.
Annuity rates are linked to the yields on gilts, or UK government bonds. Unfortunately, in the economic downturn, annuity rates have fallen to an all-time low of 1.9%, reducing the amount of income the annuity will provide. On top of that people are living longer, depressing annuity rates even more.
In response, more retirees have been looking at pension drawdown, where you keep your money invested and take an annual income from it.
This is a riskier way to take your pension income as your pension pot can continue to rise but it can also fall, and those in drawdown are also coming up against another hurdle.
The amount of income you can take each year is linked to annuity rates set by the Government Actuary’s Department (GAD), which are known as GAD rates. Unfortunately, GAD rates run parallel with the annuity rates offered by pension companies, meaning as the companies offer less money those in drawdown can take less.
It seems those pesky annuity rates hit you whichever way you turn for retirement income, so what’s the solution?
The right combination
Ray Chinn, head of pensions at insurer LV=, believes you don’t have to choose between one product and the other, and that says securing a decent retirement income means using a combination of products to suit your lifestyle.
Using part of your pension pot to fund an annuity to cover living expenses and putting the rest of the pot in drawdown to provide you with money to enjoy your retirement is a plan that Chinn recommends.
‘People think with annuity and drawdown products that it is one or the other, but it is a mix,’ he says.
‘People need to look at what they want. What income level do I need to cover my day-to-day costs? And with the rest of the money look at how much can you can afford to have in the market. Can you find a nice home for your money that will provide some drawdown income?
‘If you have the means in your pension fund secure a base line annuity and then build off that.’
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