Flexible Pension Drawdown v Annuity Warning
So many clients, commentators, newspapers, journalists and of course government are promoting the new flexible drawdown pension rules that started in April 2015.
We thought it was time to address some key issues when thinking about planning your retirement.
What is a Pension Annuity?
After having taken your option of a pension fund lump sum, the balance of your pension fund is usually invested via an insurance company giving you an income for life. This is the annuity, a yearly income.
Annuity is usually guaranteed for life.
You can usually choose an option for a spouse annuity should you die early. This can be set on first death at 100%, 75%, 50% of the original annuity income.
You can usually choose an additional guarantee, for example. 5 year, 10 year guarantee, where the original higher income amount will be paid out to your estate or your spouse for up to the 5 or 10 year period as a lump sum and then the income either stops (if it was a single life annuity) or a continued income at a lower level if a spouses benefit was opted for.
You can also select whether annuity income is paid at a higher starting “level” amount, which does not increase, or opt for a lower starting income that increases with either inflation or a fixed % rate.
The issue is on death, after first death (on a single life annuity) or second death (on a joint lives annuity), the income stops and any balance of the fund is a windfall for the insurance company if a capital protected annuity has not been taken.
The issue today is annuity rates are low given low interest rates and longer life expectancy driving annuity rates down.
What is Flexible Drawdown from April 2015?
Again, you have the option for your pension fund lump sum, that balance if your pension fund is left invested in pension funds.
These funds can rise or fall in value in accordance with where you have invested your pension fund in lower, medium or higher risk funds.
You then drawdown an income from the pension fund that is invested.
Your drawdown can be as much or as little as your require.
Under new rules, on death before age 75 your loved ones can withdraw the balance of the whole fund remaining free of tax or can continue to drawdown free of tax. They can also buy an annuity but this could be taxable.
Under new rules, on death after age 75 your loved ones can withdraw the balance of the whole fund remaining subject to a 55% tax charge, but this is being reduced between 2016 and 2017 or they can continue to drawdown income but taxed. They can also buy an annuity but this could be taxable.
The issue with drawdown is your pension fund remains invested in line with your own risk profile. What if you drawdown more than your pension fund grows? What of you spend more than you have and eventually money runs out? What if there is a dramatic investment market collapse. We only have to look back to 2007-2009 where stock markets halved in value, this could cut your pension income dramatically.
Warning - Weighing up Drawdown v Annuity
We therefore feel compelled to raise it with all clients and readers that care needs to be taken to understand the risks of annuity and the risks of drawdown. They are totally different risks but the lower risk approach for annuity still should be considered rather than simply focussing on the new flexibility for pension drawdown. Do not ignore pension annuity.
If the annuity rate return is 6% per year, will your drawdown out perform this?
If you are in good health, or of your family bloodline has longevity i.e. they live long, would a guaranteed annuity for life prove the better bet.
If you are prepared to take higher risk. If the drawdown scheme is not your only pension i.e. you do not rely on it growing. If your family has a poor bloodline, or of you have poor health or a lower life expectancy, may be pension drawdown is a better bet.
In addition, be warned that you will see more and more "non advised" online flexible pension services replace online no-advice annuity services where full commission can still be taken as no advice is given. Drawdown v annuity is complex and you may finish by paying more in commissions without advice than if you had sought 'at retirement' advice.
That facts remain, that we as your financial adviser, would need to factor these things in and project forwards the risks and income/capital needs via a cash slow projection to satisfy ourselves what is the more balanced retirement option for each client. The need for full annuity v drawdown pension advice has never been greater. Contact us for pension annuity and flexible drawdown advice.