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Mark Pearson: Annuity vs drawdown balancing act

Mark Pearson MM blog

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
     
60 £4,800 £5,115
65 £5,500 £5,849
70 £6,400 £6,908
75 £7,800 £8,441
     
Female    
     
60 £4,500 £4,894
65 £5,100 £5,572
70 £5,900 £6,510
75 £7,200 £7,842

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

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Comments

There are 4 comments at the moment, we would love to hear your opinion too.

  1. The fundamental problem remains the annuity rates trap and the fact that the government tacitly refuses to do anything about it.

    It would be interesting, though probably frustrating, to meet Steve Webb and ask him face to face why the government continues to pretend that this isn’t the core deterrent to saving for retirement by way of a pension plan.

    The best rate available to a male age 65 (in good health) for a level annuity with a 50% widow’s pension now perilously close to 5%, maybe even less. Hence we’re seeing:-

    1. unprecedentedly low numbers of people embarking on a new pension plan,

    2. record numbers of people stopping contributions to those they already have, and

    3. more and more people wanting to unlock their TFC and just park the balance of their funds elsewhere with no further input.

    Public confidence (mine included) in pensions is at absolute rock-bottom and the risks, extra costs and complexity of DrawDown far outweigh any possible future advantage

    And the government thinks that NEST is going to fix this malaise? Dream on.

    Assuming that he isn’t stupid, the only reason Steve Webb won’t stand up and call for the ART to be scrapped is that he’s under specific orders from No. 11 and the Treasury not to. Keep your mouth shut, Steve or you’ll be out on your ear. A man without either conviction or integrity or both.

  2. Need something wadical !

  3. The annuity is a cross subsidy welfare club, a mini welfare state, so much so it could have been invented by a Labour Politician . Those who die young subsidise those who live long. All very altruistic but this altruism extends beyond the family and allows personal money to benefit complete strangers! In an age where with profits, and final salary pensions etc are dying a death the annuity is sure to follow

  4. @ Julian, you are completely correct. One of the biggest deterrents to pension saving is not Millisecond’s obsession with charges or Weeble’s guarantees (they are more geared to getting votes than sorting pensions).
    The biggest deterrents are: 1) Mum, Dad and bloke in the pub saying they are crap because they have just translated perhaps their biggest asset after their house into a derisory income that, in their eyes, they will not ‘see back’ until they are well in their eighties. Plus they had to wade through a recycled rainforest of obfuscation to get their.
    2) People often do not have the money to put it in in the first place.
    Now, you and I know that as we deal with real people, Millisecond and Weeble do not. They are too arrogant to listen and it is probably politically inexpedient to do anything about solving the issue, as it would sabotage their long term tenure in their own rather comfy DB scheme.

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