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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

Drawdown v annuities: which pension strategy wins?

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.

Drawdown

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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28 comments so far. Why not have your say?

James Burn via mobile

Jun 07, 2012 at 12:44

Providing that you have enough saved to purchase an annuity that pays 20000, you can then use flexible drawdown with the rest, i.e. no limits based on annuity rates.

Even if not, the limit rises with age, so I believe even if you can't draw what you want at first, you can supplement this with other savings until you reach an age where this is not a limit.

Finally, I note that dividend yield averages better than the above annuity rate, and although stock prices are very volatile, the dividends are much less so. So if you have enough of your income from an annuity, having the rest paid from stock dividends may meet some people's preferences for risk versus reward.

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sgjhaghsdg

Jun 07, 2012 at 12:50

I'm going to grab my 25% tax free cash ASAP before they change the rules. This can then be invested so as to provide a dividend stream, on which there is no more tax for a basic rate tax payer, which beat the 20% for anything you draw from the pension.

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Rob Walker

Jun 07, 2012 at 13:21

How would anyone make a Pensions decision on this article? No mention of ISA's (a good place to get tax-free bond income from a tax-free lump sum) and, of course, the combination of state and employment pensions (some inflation-proofed), which for many will cover basic overheads. Personally, I can't see how annuities can ever be good value as they rely on giving insurance companies a profit margin. But then, for that very reason, we are always advised to buy them!

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frankie

Jun 07, 2012 at 13:23

With a SIPP I can manage my investments and drawdown - and what's more, leave the pension to my wife (not half of it) and then net of tax after tax to my children!

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dogdays

Jun 07, 2012 at 13:24

Personaly I dont trust the bastards and their fancy schemes

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Barry1936

Jun 07, 2012 at 13:28

No matter how you take you retirement pot, when you (and/or your spouse) are dead, it is also dead. So take your 25% and take the maximum income you can from your drawdown scheme but make sure you only spend what you can afford and invest the balance. if you die earlier than you hoped then at least some of your pension pot will go to your beneficiaries instead of the annuity company. If you die later than expected then hopefully the surplus that you have invested will allow you to maintain the same standard of living. Whatever you do, it is a balancing act but the more money you can get under your control the more chance you have of planning how you spend it.

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Geoff James2

Jun 07, 2012 at 14:29

@@ Barry1936

This is too simplistic and prone to failure. If the individual drinks 20 points a week, smokes 40 a day, is over weight and does not floss their teeth then this is sound advice.

For others the problems kick in when they live to 90 and it is far too late to do anything except moan and suffer. A fixed annuity taken at 65 will be worth just 25% by 90 years. The idea that we are all disciplined and have saved over the first 25 years is wrong.

A recent statistic - over 20% of the people in their fifties are going to live to be 100. A fixed annuity is not the solution unless you plan to die well before 90 or live in poverty when over 90.

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Michael Stevens

Jun 07, 2012 at 14:42

Income drawdown is advised by I.F.A. as it produces the most commision or fees.

Consider a With Profit pension from Prudential, I have one and it works very well.

A combination of perhaps three products such as Canada Life Growth account.

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David booth

Jun 07, 2012 at 15:37

I had a quote from an IFA to put about £50,000 of my pension pot into Prudential With Profits Pension & very roughly his take over 10 years was about £10,000! Not bad for a couple of hours work! Which of these cheating b------s is going to cheat the investor least? Don't forget they offer no guarantees.

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Ivor Nestegg

Jun 07, 2012 at 17:09

Here we go again, an Insurance salesman trying to persuade us that annuities are a good idea when the reality is that one hands over a lifetime's pension savings in return for a pittance. Only a fool would do so voluntarily.

Like Dogdays, I too "dont trust the bastards" - what a pity our law makers seem to do!

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RippedOff

Jun 07, 2012 at 17:14

Michael/David/Ivor.

Your right about IFA's. I'm still looking for one that is compitent, doesnt charge the earth and I can trust.

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Simon Wake

Jun 07, 2012 at 19:52

James Burns should note that the state pension can be counted towards the £20,000 secure income required for flexible drawdown.

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Digger

Jun 07, 2012 at 20:18

Don't worry, the insurance companies and the SIPP providers make sure you will not have a chance of getting your hard earned money back, unless you can live to 120!!! ISA.s everytime, but you will be restricted how much you can put in there too!

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Peter Reeves

Jun 08, 2012 at 08:43

Annuity rates have NOT fallen to 1.9%. The yield on gilts has - which influences them - but annuity rates are around 6% for a 65 year old. Of course, this 6% includes return of your capital - all of which effectivey disappears the moment you take an annuity. Many would find it more sensible to operate a low cost SIPP invested heavily in bonds generating 4%+ interest and income-focussed equities yielding almost as much (with chance of increase but risk of decrease). Then take income as needed while keeping all the capital intact (subject to market fluctuations).

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Daniel Lewis

Jun 08, 2012 at 10:18

There is no 'one size fits all' approach to this subject I am afraid. A great solution for Mr Jones is a poor one for Mrs Evans, so moaning about the right and wrongs of ths article is pointless. You are aware of your own situations and if you have the expertise to manage your retirements on your own then do so. If not, seek professional guidance and as with anything in this life, expect to pay for it.

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Ed Bowsher

Jun 08, 2012 at 17:24

I just want to endorse the comment from Peter Reeves about annuity rates falling to 1.9%.

You'd have to be very young and in very good health before you'd be offered that low a rate!

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Jo Public

Jun 09, 2012 at 09:07

Annuity rates have been influenced by statistically rising average life expectancy. This trend seems likely to be reversed by NHS Reforms, cuts to Social Services, and so on. I sometimes wonder what the insurance companies will do with all that windfall capital descending on them from unused pension pots. Dividends?

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Leigh Moss

Jun 09, 2012 at 09:27

I was thinking of taking my 25% out and purchasing a property to rent using the income over the next 10 or 12 years to increase my savings ready for when I actually retire. I'm 2 months away from being able to take the 25%.

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snoekie

Jun 09, 2012 at 12:05

Jo Public, partly dividends, and then the tax man gets a hefty sllce of the profit as well.

Now on a SIPP, if you shuffle off before 75, the tax man takes 36% and after 75 he takes 56%. Ain't that age discrimination?

I wouldn't mind the 56% so much if he didn't also take his 20 on divis and another 20+% when you draw down.

On top of that, the charges of the SIPP provider are quite sizable, for the work (investment decisions and receiving the info about the investments and dividends etc) that mostly is done by the individual, on top of the chunk that was taken by them on set up, a pre prepared form, standard wording, printed out by the computer, with the name and address of the individual, perhaps spouse and children added. In my case the charge was £750, could be avoided, money for old rope, no spouse, but 2 kids.

The most that they do is get the brokers notes, and sign the odd cheque, no change out of £1000, ANNUALLY.

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snoekie

Jun 09, 2012 at 12:23

BTW, I forgot, most SIPP providers have their own "bank" branch, pay zilch interest but have no doubt negotiated a nice little deal with the bank to pay them because the deposits would invariably be quite sizable, probably in the millions (maybe even 10s of millions) as the dividends and bond yields accumulate awaiting drawdown/investment.

£25 just for receiving and filing a piece of paper, and then they still ask you at the end o the year what investments have been made, even when they get the info, which they file (not forgetting to note receipt because that is more boodle for them at the end of the year).

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Jo Public

Jun 09, 2012 at 14:07

Well thanks Snoekie! Just when I thought I couldn't get any more cynical .....

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snoekie

Jun 09, 2012 at 20:20

Request for info.

Can the accountants amongst the contributors confirm, on drawdown, can we demand from the SIPP provider an R185, tax deducted at source to save having to pay yet more tax when drawing dowin?

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Dislexic Landlord

Jun 10, 2012 at 08:56

Hey I have just come up with a bussiness Ideir

Give me you earned cash and I will arrange for the Govt to give you 20% and add it to you money in my pocket

SOUNDS GOOD

I will manage your money every year and I will charge you lets say 1.75% every year I will charge you if i do a bad job or a good job (Im not Really Botherered what ever it dose and I will give you a atatement declareing it and telling you also what up fron commision I will charge you for entering my plan )

Now when you want your money back I will give you 25% of your money back

leaveing me 75% of your money in my pocket

I could arrange for you an income of around 3% for the rest of your life and when you die I keep your 75% so your children and grandchildren will get nothing for your hard work)

Oh by the way I must tell you that the govt who controls how I hold your money may change the rules so i cant be responcable for that of course

I know im being childish with the above but is this not a personal pension fund

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sgjhaghsdg

Jun 10, 2012 at 18:23

@Dislexic Landlord - It's a personal pension fund, but not one that I'd ever use. You can easily avoid the 1.75% pa by using low-TER trackers and/or ETFs and/or whatever else you choose. You can also use drawdown, which even with today's low GAD rates gives way more than 3% pa and the pot is also available for dependents to use for income if you pop your clogs, and failing that they can take it after paying some tax on it.

I don't use an IFA, I don't use high-fee pension funds, but I do use pensions. If others choose not to use pensions, well they have the freedom to not do that.

I can't see the problem.

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Dislexic Landlord

Jun 10, 2012 at 21:33

FAO sgjhags

You are well informed and I would imagin have looked very carefully when you have invested

Most every day folks havent a clue and thats the point im makeing here most are sucked in with Tax Relife but look no futher

I still think in genaral Personal Pensions are a con there are exceptions to the rule but I would only invest in ISA

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sgjhaghsdg

Jun 10, 2012 at 22:25

@Dislexic Landlord - ISAs and pensions are different tax wrappers but can hold (mostly) identical investments. I use both ISAs and pensions, and would be without neither as each has their role.

"Everyday folks" can pretty much do as they please. The only point where I drawn the line is when they try and spread disinformation to others.

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Mark C Digby

Jun 10, 2012 at 22:32

Dislexic Landlord above. If you care to read my comment June 7above, you are repeating my sad expeience. Unless you are investing many thousands of pounds in a SIPPS, you will find, as I have, that most of the capital is lost in charges. I had put just a few thousand thinking they were a great idea, now the fund is down to about £6000, I am only allowed to take a few hundred out annually, and the charges are now over 10% of the drawdown amount!! If only I had understood the small print! As I am now in late 70s most of the £6000 that is left may well go to either the agent or the tax man!!

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Dislexic Landlord

Jun 11, 2012 at 06:43

FAO sgjhaghsdg

You last phrase said it all disinformation says it all

Life company have always glossed over the true facts in my opinion

The East End Boys in West End suits never gave full facts and if you want to see everdence of the fact just look at illastrations that were given to customers in the 1980.1990,s

They were forced to disclose Commisions and charges but this clarity did not come from Life Companys it came through regulaitors

We need pensions dont get me wrong but the deal at present only lines the pockets of Life companys

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