FOLLOWING last week’s column on targeted pension strategies, in which I mentioned annuities, I thought I would cover the difference between annuities and pension drawdown.
When I was a young lad in this role, everyone took out an annuity. Today, those accessing their pension plans for the first time is closer to one in 10.
This was because of the very low interest rates we had for many years, and when pension freedoms arrived, there was no real need to have one.
An annuity is an insurance product that allows you to swap your lump sum for a guaranteed income for the rest of your life. They have their advantages and disadvantages, and understanding those and how they apply to you is everything.
Fundamentally their benefit to the plan holder is security and peace of mind.
Gambling and worrying at retirement isn’t as palatable to some people as others and sometimes it’s just easy to switch off all thoughts of potential permutations of investment fund choices, choosing the right drawdown levels, potential overall fund depletion, inflation, charges and markets, to instead opt for: “I’ll have one of those guaranteed income things so I can focus on my golf”.
It allows you to make that one decision with your pot then close the file for good.
With interest rates higher, annuity rates have rocketed and are 40 per cent higher than they were in 2016.
I can see how this is attractive to investors and with economic uncertainty and cost of living issues bashing your head in your sleep, research shows that one in three people who are now approaching retirement are considering an annuity. 55 per cent of those have only recently decided to make that decision. That also marries research showing that annuity enquiries are up 58 per cent.
Which should you go for then, an annuity or drawdown?
Downsides of an annuity are that once the capital is invested, that’s it. That’s your lot. You’ve bought your income and that’s gone. If you die soon after, the insurer pockets the lot. Your gamble didn’t pay off.
You can get around that by building in guarantees like five years of income or make it a joint annuity, so it keeps paying your partner after you have died, but with all of these guarantees comes a reduction in your starting income levels. No free lunch.
Interestingly, this is one of the reasons many people do not like to take out annuities – they tend to underestimate their own life expectancy, believing they will be dead before they receive fair value back from their annuity purchase. Instead, when they live longer, and much longer, they would really have gained with an annuity – and the insurer would have lost, yet most believe the annuity offers them a bad deal.
An annuity offers a stable income, a chance to put in guarantees, less stress, more security, and potential built in inflation protection. If you are in bad health, the annuity will pay out a higher income as the life expectancy is lower.
Of course, you know you do not need to buy an annuity from the company you have the pension with. The rates available in the open market vary significantly so be sure to use an independent financial adviser to check who is offering the best terms.
Pension drawdown offers you much greater flexibility, but still with ongoing decisions to make with your money and the stress of fund choices and preferred income levels.
You have the flexibility of deciding what income you would like to take and when. You have the ability to manage it and gain from stockmarket returns and wait until later life to buy an annuity, and of course, the older you are, the lower the life expectancy, and the greater the income from the annuity.
Furthermore, if there was an early death after taking out a drawdown, your family will receive the full lump sum value of the pension, free of inheritance tax.
Undoubtedly one of the most important aspects to this is the management of the money and this requires the specialist advice of an investment IFA. Returns and fund management can be extraordinarily varied.
Peter McGahan is chief executive of independent financial adviser Worldwide Financial Planning, which is authorised and regulated by the Financial Conduct Authority. For advice on pensions call Darren McKeever on 028 6863 2692, email info@wwfp.net or visit wwfp.net
