Drawdown plans provide greater flexibility than secured annuity alternatives but there is a price to pay and it is a strategy that does not suit everyone.
Conversely the price that pension savers pay for the security of an annuity is that, with continuing low gilt yields, the rate at which capital is converted to income remains disappointing. They too do not necessarily suit everyone.
What can pension savers do to get the most from their capital?
One answer is perhaps to make sure that they have the right balance relative to their income needs and the risk that they are prepared to take. Everyone is different which means each saver has to take their own individual decisions.
In terms of risk, it is easy to focus on investment risk but when it comes to retirement income the risk is more in relation to tolerance to volatility. Conventional annuities offer a known regular income stream whilst capped drawdown varies depending upon a range of variable factors.
Those who are less able to cope with the unpredictable nature of investment based solutions should focus more on the annuity options, accepting that they will have less flexibility.
Those who can accept that income levels will vary over time should still ensure that they can at least cover their day to day living expenses before considering drawdown. It is frequently said that annuities offer poor value for money but the same factors that influence annuity rates also impact on drawdown income.
Let’s look at some examples of annuity v drawdown, just in terms of income alone and ignoring the possible wider suitability issues.
|Male||Capped drawdown||Conventional annuity|
Figures based on a £100,000 fund and gilt yield of 2.25 per cent. Annuity rates
are from 17 September 2012 and are monthly in advance, non-guaranteed level and
with no spouse’s benefit payable on death.
As we can see, the tables have turned somewhat in that the conventional annuity now seems to offer more starting income without the risk that is associated with drawdown.
Of course, that doesn’t tell the whole story because when you start to factor in spouse’s pension and escalation etc. The annuity starting point begins to reduce. With drawdown, the client retains some flexibility with the residual fund but if they are too heavily reliant upon the maximum withdrawals then not only might their income levels fall but the residual fund on death may not be sufficient to purchase a reasonable income for the surviving spouse.
We know all this, it is not new and it is a matter of “horses for courses” but we can help our clients by:
Injecting some realism into their expectations
Ensuring that the essential outgoings are covered as a priority
Diversifying where we can to generate a blend of solutions
Above all we can ensure that they are understanding risk not only from an investment perspective but also from the point of income volatility and the damage that can be caused for the unwary.
Mark Pearson is director of business development at Origen Financial Services