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Prime motivators

I am currently taking the maximum income drawdown from my pension fund. I am 61. Would now be a good time to convert to an annuity?

It may well be that you would be converting your invested pension fund into an annuity when the former is at a low point in the investment cycle but the latter is benefiting from a bit of an upswing.

If your pension fund has been invested in a range of asset classes – cash, fixed interest, property and equities – then this, with the taking of maximum income withdrawals, will probably have resulted in a pretty significant capital value reduction.

While this is not unexpected – it is always disappointing. I hope your adviser will have warned you about the volatility and risks associated with unsecured pension.

If you buy an annuity now – if that’s the right thing to do – then you are shifting away from the twin risks of poor future capital investment returns and future interest rate reductions. I suggest you revisit the original reasons why you selected income drawdown as opposed to buying an annuity at the time you established your plan.

When faced with either drawdown or annuity, there are several quite common motivators.

Initially, drawdown might have provided a higher level of income than that from an annuity. It may also be that you have other income sources and you wanted the income flexibility that the alternative to an annuity offered. For some, the attraction of a capital sum (albeit taxed) being passed onto the next generation too soon after death also outweighed the relative certainty of the annuity.

In addition, if you also established this arrangement in the recent past, then you wanted to take the tax-free cash lump sum without taking income – but more lately decided that income was required.

To many, a combination of these points represent a reasonable alternative to the annuity.

If the above no longer apply, then yes, considering an annuity purchase now makes real sense. Be aware though that the chances are the level of the annuity income that you receive will be lower than that you are currently taking from your income drawdown plan.

Put simply, this is because the annuity is going to be at least 20 per cent lower than the maximum income drawdown. It is, obviously, slightly more complex than that so please forgive me for my over-simplification.

The more options you add into the annuity – such as provision for continuing spouse’s pension on death, increasing annuity level in course of payment, and any shorter-term guarantees – the bigger the likely difference between the annuity and the level of maximum income drawdown.

However, you are giving up a degree of uncertainty for certainty of income and that may be a stronger driver of your decision than any of the above.

Remember, future annuity rates may be lower than they are today. While they do tend to rise as you get older other factors, such as long-term gilt yields, are a strong influence over rates available. In other words, delaying the decision may not result in better income in the future.

That said, if there is a recovery in, for example, stockmarkets, you may see a reasonably rapid increase in the capital value of your pension fund and its ability to generate future income. Neither option is without risk so you will not be surprised if I say take specialist independent advice before you act.

Nick Bamford is joint managing director of Informed Choice

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