Had you’d asked me 15 years ago how I planned to fund my retirement, my answer would have been straightforward.
- A certain proportion of my retirement income would come from a modest defined benefit pension, built up in the 1980s.
- The state pension would make up another modest slug of income
- The balance would come from an annuity, after I’d cashed in my pension savings.
These days, my thinking is a little more nuanced.
In particular I’m a hell of a lot less enamoured of annuities than I used to be. And a hell of a lot more interested in the alternatives.
Poor value annuities
For one thing, in the intervening years annuities have had something of a bad press.
Thousands of Equitable Life ‘With-Profits’ annuitants, for example, got royally shafted. Having exchanged their pension pot in exchange for an income for life, in the early 2000s they saw their incomes effectively halved – or worse — as the board of Equitable Life scrambled to conserve cash. Hardly a just reward for responsible saving.
Around the same time, annuity rates began a headlong plunge from which they’ve yet to recover.
Blame greater longevity, and increasingly derisory bond and gilt yields.
Hence the growing attraction of income drawdown, introduced by the government in 1995 to offer an alternative to annuities.
Income drawdown: Mine, all mine!
Income drawdown provides pension savers with the option of each year ‘drawing down’ a little of their pension pot, gradually consuming the income and eating bit-by-bit into the capital.
So instead of handing over your entire pension pot to an annuity provider in exchange for a guaranteed income, you draw down upon the capital sum that you’ve accumulated – deaccumulating, in today’s jargon.
At all times your pension pot remains yours – because you’re not handing it over to the annuity provider – and, upon death, what’s left can be passed on to your heirs.
Of course there are some downsides to income drawdown:
- There are charges that you don’t get with annuities.
- If you consume your capital too fast, you’ll drain your pot dry.
- Market volatility can mean that capital consumption when markets are down is especially expensive.
The biggie is that an annuity income is nailed-on for life when you buy it – albeit at a pretty poor rate today – which gives you security in exchange for flexibility.
Income from drawdown isn’t secure.
The annuity empire fights back
While miserly annuity rates have attracted a bad press in recent years, income drawdown hasn’t had that good a press, either.
I, for one, was initially put off – no, horrified – by some of the charges being levied by the Independent Financial Advisers and specialist firms offering income drawdown schemes.
Not to put too fine a point on it, some of the same firms that had been offering precipice bonds and zero-coupon bonds now seemed to be offering expensive income drawdown schemes.
Moreover, the traditional annuity providers apparently flooded the finance pages of the weekend press with scare stories. (Cynical? Moi?)
Take this one from the Daily Telegraph in 2012, which began:
Income drawdown: the pension that could leave you penniless
Avoiding annuities could give you more to live on to start with, but your money could soon run out if markets go against you.
The article warned that retired people who took the maximum income from their policies would empty their pensions by the age of 92 – even allowing for a relatively benign investment climate.
Er, yes. But why would you have continued to drawdown at maximum levels if you saw that starting to happen?
Income drawdown limits – imposed by the government explicitly to prevent pensioners from consuming their pots too fast, doubtless prompted by articles like the one just mentioned – also made for grim headlines over the years.
When in 2009 the government cut maximum drawdown from 120% to 100% of the gilt-linked (and already reduced) GAD1 rates, high-drawing pensioners’ incomes duly fell.
In other words, they couldn’t draw down as much as they has previously assumed – and it would be potentially imprudent to do so.
That wasn’t quite the way the Daily Telegraph pitched it, though.
“Our pension was cut by £9,000 a year”, it shrieked, following it up with a dire headline that pensioners faced a 40% income cut.
Recent developments in retirement income
This sort of reporting, while ostensibly balanced, does little to encourage people to weigh up the pros and cons of annuities versus drawdown.
That’s particularly true if such people are reasonably sophisticated investors, who are used to taking decisions about their financial future, and who are perfectly capable of taking an educated view of the relative upsides and downsides of these two contrasting approaches to the deaccumulation phase of our lives.
People like Monevator readers, in other words.
And to my mind three recent-ish developments have tipped the balance even more in favour of income drawdown, and away from annuities.
Development #1: Equity income beats low annuity rates
In March 2009, the Bank of England cut Bank Rate to a historic low of 0.5%, ostensibly for a few months – perhaps a year at most.
Five and half years on, it’s still there.
And whereas the mood music even a couple of months ago was talking about a rate rise in a few months, the prospect of an imminent rate rise now looks slim, what with signs of a slowing economy here in the UK and further trouble in Europe.
In the meantime, annuity rates reflect these persistently low interest rates.
Consider the following annuity rates, sourced from Hargreaves Lansdown, in respect of a single life, investing £100,000 to buy an Retail Price Index-linked (RPI) annuity.
| 55 | 60 | 65 | 70 | 75 | |
| Single life, RPI-linked, 5-year guaranteed annuity |
£2,249 | £2,286 | £3,285 | £4,265 | £5,722 |
Source: Hargreaves Lansdown, October 2014
Said differently, someone retiring at 55 is going to do so on an index-linked income of 2.25%. At 60, 2.3%. And at 65, 3.3%.
That’s pretty derisory, when you consider that a portfolio of solid income-oriented, dividend-paying shares could deliver double that yield between the ages of 55 and 64 or so.
Even at 70, your annuity will give you less than many decent dividend picks are paying out today – and with the annuity you’re kissing your capital goodbye, too.
Plus those dividends from shares should rise over time, providing a cushion against inflation. To be sure, not in a smooth and consistent way that’s guaranteed to match RPI. But very likely at a greater clip, overall.
In short, for investors prepared to shoulder the burden of picking shares or income funds – and taking on the risks of equity income – then income drawdown currently offers a higher income – potentially without necessitating any capital drawdown at all – and provides a potential capital bequest to boot.
Development #2: Goodbye, income cap
Remember those shrieking headlines about pensions being cut by £9,000 a year and pensioners facing a 40% income cut?
Er, that was then, and this is now.
As of the Chancellor’s most recent budget, the GAD limit was first sharply relaxed2, and then abandoned altogether in respect of drawdown schemes commencing from next April.
As pensions minister Steve Webb famously observed, there will now be nothing to stop pensioners withdrawing the lot, and blowing it on a Lamborghini.
Nothing, that is, except for the fact that – aside from the tax-free lump sum entitlement – such withdrawals would be at an individual’s highest marginal tax rate, calculated by including the withdrawal as part of annual income.
Ouch.
And nothing apart from the fact – as the government hastened to point out, post-Lamborghini foot-in-mouth – that it rather thought that people who’d been sensible enough to spend a lifetime accumulating a pension would probably be sensible enough not to blow it all at once.
Still, all in all your pension has just become one giant piggy bank, with no limits on how you choose to extract money from it.
Quite a contrast to swapping it for an annuity.
Development #3: Goodbye ‘death tax’
Thirdly and finally, the recent party conference season brought a welcome bribe fillip to pension savers who have an eye on passing on the unused part of their pension to their heirs.
Simply put, the old 55% tax hit levied on your pension estate is to be scrapped, proposes the Chancellor.
- If you die before age 75, your pension can be inherited – and money withdrawn from it at will – with no tax to pay at all.
- If you die after age 75, the inherited pension will attract no tax if the funds are left within in it, but any withdrawal will be at an individual’s highest marginal tax rate.
Again, quite a contrast to an annuity.
The inheritance tax benefits are obvious, and already I’ve read press coverage suggesting that such a system would open the doors to multi-generational ‘trust funds’.
Needless to say, you can’t do this with an annuity, either.
Tipping the balance
So there we have it. Do these changes influence your view of income drawdown? Enough to tip the balance over annuities?
As ever, please do share your thoughts in the comment section below.
Please remember that these are difficult decisions with long-term consequences for your retirement and security, and you may need to seek professional financial advice. Our articles are for education and entertainment only, and are not meant to be taken as individual advice.
Comments on this entry are closed.
My thoughts have always been heavily towards drawdown, and the recent changes only make that a more attractive option.
The 2nd point about draining the pot dry too fast is the one I most often see touted by the media and pensions industry and yet comes across as patronising and unhelpful. I’ve no doubt that anyone able to accumulate a decent sized pension pot is probably capable of making informed withdrawal decisions and able to adjust that rate depending on the market performances and remaining fund value.
Of course the state pension amount will have a huge impact, assuming it’s still around at my state retirement age in 40 years time and the country hasn’t resorted to workhouses and bread handouts..
Personally, I’ve been following the updates with interest but not getting too excited about them as they will all no doubt change again by the time I’m in a position to retire. Who knows, by then, annuities might be attractive again!
I am of a view that there seem to be too many changes being introduced all at once. These changes may be perceived as being positive because they give people choice, but too much choice can also be confusing to your average person who may not be as financially aware or as informed eg Monevator readers.
The balance has shifted massively towards drawdown, certainly at the beginning. There’s maybe a case to be made for switching to annuities later on when the yield becomes acceptable (from your results roundabout 70) for the guarantee of not outliving the money and saving the aggravation of staying on top of the investing if there aren’t inheritance aims
Hi Greybeard,
I think the mainstream media’s habit of attacking different products in turn is deeply unhelpful and only serves to paralyse rather than educate the public. Certainly annuities have come under assault too and it only serves to obscure the fact that there are some good products out there that can be the right choice for particular people under certain circumstances.
I encouraged my mum to buy a RPI-linked annuity and it’s the best decision I think either of us have made in years.
She’s not capable of judiciously managing a high-yield portfolio and was mostly stuck in cash that was being undermined by inflation.
The annuity has put an income floor under her, along with the state pension, so she can be assured of a consistent cash flow to handle the essentials, with remaining assets free to provide some upside.
The peace of mind is priceless.
“Equitable Life annuitants, for example, got royally shafted. Having exchanged their pension pot in exchange for a fixed income for life, in the early 2000s they saw their supposedly guaranteed incomes effectively halved, as the board of Equitable Life scrambled to conserve cash. Hardly a just reward for responsible saving.”
No, sorry Greybeard, this is totally inaccurate, and dangerously so.
If you’ve based your article on this premise, then you’ve built a house on sand.
Equitable Life cannot change the terms of fixed-income annuities. If it did so, it would be declared insolvent.
You have mixed up the fixed-income annuitants with those who took with-profits annuities. a totally different thing. Fixed-interest annuitants of ELAS are doing fine, thanks. The disaster that has befallen those with with-profits annuities ought to be an argument AGAINST investment-based retirement income (such as drawdown), not for it.
This is a monstrous article, which could have grave consequences for the unwary reader. You have made a fundamental error in your analysis. You should withdraw it.
The idea of handing my pension fund to an insurance company always horified me
The idea that the thieving weasels who took money for home and car insurance cover every year and then never paid out would suddenly become saintly when handing me out an income from my retirement funds was never one that seemed believable to me
Its nice to see the government attacking an entrenched vested interest as aggressively as they have attacked the pension industry, but it just shows how much they could do with others like the banks and the NHS
I think its only too likely that many people will use the new pension freedoms recklessly – just as many people get into trouble using freely available credit. I’m not sure what the answer is, but if I was running the government, I’d be very worried about the size of the bill I would need to pick up once people ran down their savings and became dependent on the state. In fact you could argue that the new changes actually incentivise those with modest savings to take them and blow them on unnecessary spending, and then take their chance with the state ‘safety net’. That would seem to be quite a rational set of actions.
Think it won’t happen? Read the Bogleheads forum for tales of friends and relatives burning through their retirement savings (though their Social Security actually seems like a more generous safety net than our state pension…)
Surely all this extra choice in pensions is a good thing.
It allows us all to plan for our future with our own money.
Ok, some people will make mistakes.
But don’t some folk do that already with their income, spending excessively on alcohol/drugs/cars/holidays/junk food/fags/whatever? Pension savings are unlikely to be spent differently by these people.
I welcome the new freedoms, hopefully they will cause the British public to take more interest in their own financial wellbeing. There is no one-size fits-all answer to this qustion, and thank heavens for that.
There is a nice summary of the equitable life debacle on Wikipedia. The trouble started in the early 90s when current annuity rates fell below the guaranteed annuity rate of some policies. Apparently believing that they could make downward adjustments to Guaranteed Annuity Rate (GAR) policy terminal bonuses if necessary, Equitable failed to hedge its liabilities. When they did try to reduce terminal bonus payments on GAR policies in the late 90’s there was a legal challenge which Equitable lost. They became exposed to huge liabilities they couldn’t meet and the rest is history.
The message I take from this is to spread risk. Perhaps buy two modest annuities with different companies to top up the state pension which buys peace of mind against out-living savings and a poor run of inflation / investment returns. Then invest the rest in a 60 / 40 low cost index portfolio.
FWIW starting next year and subsequent years, I am planning to withdraw the maximum (avoiding the 40% and above income tax rates) from our (I’m married) DC pensions. This money will be blown on various Vanguard tracker ETFs inside ISA wrappers. We will then use the natural yield as additional income with the capital available for a “rainy day”. No rainy day = kids inherit it.
Many thanks for a great article. Although I enjoy all the investing/saving stuff from the Monevator team, I have long thought that there is more room for articles on pensions. Well done!
Greybeard, old fruit; you really should engage with Jonathan’s point that it was the With Profits annuities at Equitable Life that hit the fan, not the level rate annuities.
There is a new video from Equitable Members Action Group (EMAG) on YouTube about the parlous state of the government’s promised compensation re Equitable Life:
http://www.youtube.com/watch?v=q20PRTj_tSM
It just shows that you can’t really trust politicians (but you knew that already, didn’t you).
I see where you’re coming from with your article, although I think there’s a couple of key points you’ve not addressed:
1. Whilst ‘informed’ individuals (e.g. Monevator readers) may be able to understand, accept and manage everything that comes with drawdown, the fact is that the majority of retirees will simply not be willing to put in the required homework. Couple that with the fact that the government, media and every other man and his dog are poo-pooing annuities and the risk is that too many ordinary punters will end up with a retirement product they do not (want to) understand, simply because it can provide them with more capital/income NOW – i.e. they will treat it like a bank account. Who will pick up the pieces then – taxpayers of course!
2. You’ve also only considered RPI linked annuities which, I have to agree, represent pretty poor value for the majority of people (not for Mrs Jones who ends up living to 120 though!). However, what about level annuities which will still be a sensible option for a lot of people, even if only used to secure a minimum income floor?
I just think too many retirees will end up in drawdown, balls it all up, and end up getting less out overall (i.e. by the time they pass) than a simple level annuity would have provided them with.
“an individual’s highest marginal tax rate”: God knows which half-educated civil servant put this phrase into Osborne’s speeches, but it’s plain wrong. “Income withdrawals will be taxed as income” is a simple, accurate statement.
Two omissions: first, for people on, or about to get, old-style State Retirement Pensions there are two ways to buy an inflation-protected annuity that might appeal. (i) Defer their SRP and take the reward as an extra pension of 10.4% for each year of suspension. (ii) Buy Class 3A NICs.
Secondly, IHT: if an annuity results in your finding yourself with regular surplus income, you can gift it away free of IHT without having to survive seven years.
We’ve not bought any annuities bar by route (i); we expect also to use route (ii). But then we have DB pensions. If we didn’t maybe we’d go for a blend of drawdown and annuity, perhaps drawdown to begin with and annuity at, say, 75.
Regarding the death tax, how does this affect the offsprings LTA?
e.g. I am 36 now. Say I build up a SIPP of 1.25 million so hit the LTA then enter drawdown at 58 years old. I die at 60 so my child inheritis my SIPP and can draw income from it tax free for life?
This sounds too good to be true.
I am seriously thinking about opting out of my NHS pension scheme next year when it changes for the worse and just put 40k a year into a SIPP.
@mikka — Eek, I’ve accidentally junked your second comment while moderating spam on my phone! Apols, will hopefully be able to retrieve it when back at the ranch.
Jonathan:
You’re right: my use of the word “fixed” was sloppy. It was of course the WPA members who were affected, and the wording has now been changed to make this clearer.
Mikkamakkamoo:
The whole point was to try and compare like with like, hence equity income vs. RPI-linked annuities. It doesn’t take too many years of modest amounts of annual inflation to nevertheless deliver a big hit in living standards, at a time when people can least afford it.
@The Investor – no worries. Had my browser window still open so will repost!:
@dearieme – Steve Webb announced that the current figure of 10.4% is to be reduced to 5.8% from 2016 (and lump sum option to be removed):
http://www.theactuary.com/news/2014/07/webb-cuts-deferred-state-pension-increase-to-58/
Excellent article. I always thought annuities were the biggest legalised robbery ever devised.
The idea of the government obliging a person to hand over his/her life’s savings to one of a few companies who fix the rates between them was always abhorrent.
But I must say, I was very surprised that it was a conservative government, run by a very rich and privileged stockbroker who, who had the courage to put things right. Labour were too busy pulling their forelock.
@Franco – you seem to be saying that annuities should never be purchased, which I think is at best misguided. Clearly, whilst the benefits of drawdown have (or will – we’re not there quite yet!) been much improved, there is still a place for annuities for quite a large proportion of the population in one form or another and/or at some point during their retirement.
@ nearlytoolate @ mikkamoo
There was never a safe choice under the old system for DC – you had to buy an annuity from a relatively opaque private insurance company and hope for best. These contracts always has clauses that would screw you, no pension for a second wife for instance
There will be a lot of horror stories about people left relying on the state after losing their pension fund on some dumb investment but it was ever this. I can remember the sob stories in the Sunday broadsheets about pensioners losing their pensions and homes through being Lloyds names and there were jujytmany before that in the 70s
The new DC pension system smacks very much of political expediency but there is enough information out there and easily accessiblee for people to decide on their own retirement strategy…
…or of course you can hand a quarter of your investment returns to Hargreaves landsdowne and some nice fund managers with very nice cars
I agree with Mikka (and The Accumulator above). I can certainly imagine buying an inflation-linked annuity with a chunk of my pension pot once I’m into my mid-60s, say.
In this calculation I presume I’ll have quite a bit of change to play with, of course. Enough to make swapping say 1/3 of the capital for a much smaller income than I could get through drawdown for a *secure* and inflation protected chunk of income a very palatable option.
The difficulty for the past few years has been people retiring into a world offering the sort of slim rates Greybeard’s table documents above, and likely without substantial pots to spend, either. So locking in a low income for the rest of their lives.
For those people, the ability to take some risk and volatility in return for a higher income must seem like a godsend.
I agree equally though with the comments that most people probably won’t be well-suited to making these decisions, and related, that the potential for high charges and even mis-selling is clear.
For anyone under 50 it’s all a reminder to save, save, save and invest so you have options. The great thing about the government’s changes is (for now at least) we can do so in the hope/belief that we’ll have quite a bit of freedom to make these decisions later, compared to the pensions of yesteryear.
For me the pension changes are the best thing since sliced bread, now you can continue to manage your pension in the draw down phase just like you managed it in the build up phase. For anybody, including me , who manages their own SIPP it gives them a lot more choice.
However for anybody who doesn’t manage their own pension and just pays into it without knowing whats happening inside their pension then the sharks will be circling remember, precipice bonds, split capital investment trusts, property unit trusts where redemption’s were refused, the list is endless.
@dearime: “God knows which half-educated civil servant put this phrase into Osborne’s speeches, but it’s plain wrong.”
It certainly is plain wrong! For a start, there is no “highest marginal tax rate” because each individual only has one marginal tax rate. On top of that, as you say, it will be taxed as ordinary income, which means that in a lot of cases it won’t all be taxed at the same rate. I suspect that only a political staffer could be uneducated enough to come up with that phrase, but I am biased because I have worked as a civil servant (but not in the UK).
Is it wrong though? Do we know for sure that drawn down pension will be taxed in the same way as other income? I thought that phrase was used to signify something different – i.e. that if your other income put you in the basic rate band, then all your draw from your pension pot would be taxed at basic rate…If it’s just taxed as income, why would he not just say that, rather than choosing words that mean something different?
Well it certainly is taxed as income. I managed to get Friends Life to send me all of my “trivial” DC pension between the announced start date (sometime in March) and 5th April 2014. They removed approximately 20% tax from 75% of the payout. As I had had a low income for the tax year 2013/14 I got a tax rebate of around £600 from our kind friends at HMRC. If I hadn’t been quick off the mark I wouldn’t have been able to get the tax back (as I have other pensions now paying out).
@Jed – I totally agree – best thing since sliced bread – actually better.
@dearieme – I totally agree, we could do with less jargon and more clarity in pensions all this “highest marginal rate” stuff is tosh.
@Mikka: “for people on, or about to get, old-style State Retirement Pensions….” is what I said.
“it was a conservative government, run by a very rich and privileged stockbroker”: eh? Who?
“you had to buy an annuity from a relatively opaque private insurance company and hope for best. These contracts always has clauses that would screw you, no pension for a second wife for instance”: what?
“…or of course you can hand a quarter of your investment returns to Hargreaves landsdowne”: my golly, your returns must be very low.
“I suspect that only a political staffer could be uneducated enough to come up with that phrase”: good point. A future PM no doubt.
“Do we know for sure that drawn down pension will be taxed in the same way as other income?” It is at the moment. For the future, you’ll have to ask Krystal Balls.
Hello everyone. The Greybeard here.
We’re spending a lot of time on this “income versus highest marginal tax rate” debate, and I thought I’d chime in with some worked calculations from Tom McPhail at Hargreaves Lansdown.
Investor 1, George, overall tax rate equivalent to 15%, top rate paid: 40%
Earns £20,000 a year and cashes in a pension worth £30,000. Taking account of his personal allowance, his tax free lump sum entitlement and his existing income, George will pay a top rate of 40% tax on his pension and suffer an effective tax charge of 15% on the pot overall, costing him £4,627.
Investor 2, Steve, overall tax rate equivalent to 27%, top rate paid: 40%
Steve earns £30,000 a year and is cashing in a pension pot of £90,000. He’ll end up paying an top tax rate of 40% and an overall effective tax rate of 27% on pension fund, costing him £24,627 in tax.
Investor 3, David, overall tax rate equivalent to 32%, top rate paid: 45%
David earns £40,000 a year and has a pension pot of £300,000. David will pay a top rate of tax of 45% (though he’ll suffer an effective tax charge of 60% due to the loss of his personal allowance) and an overall effective tax rate of 32% on his pension pot as a whole, costing him £95,750 in tax.
Makes of this what you will, although I’ve always found Tom to be very reliable.
@Jed: Bang on the money. That’s the point.
The Greybeard
Sorry I’m none the wiser. Very strange examples too. Why would people becashing in pensions when they are still earning? Isn’t the purpose of a pension to support you once you no longer have earned income….
We live in strange times indeed…
@Vanguardfan: Retired or not, it’s your earnings in a given tax year that dictate your tax bill.
@greybeard, you mean income, I think, not earnings…(income may be earned or unearned..)
Nevertheless, my point was that these are interesting examples to choose to illustrate pension drawdown…where are the examples showing people with income from pensions in payment (state or defined benefit)?
Anyway I think I infer from that, that the proposal is indeed to tax pension drawdown in the same way as other income ‘slices’ – though with the added nuance of 25% being tax free. In which case why on earth did Osborne suggest something else?
Its worth remembering that personal pension rules just lend themselves to tinkering by the government of the day
Since for the next decade its absolutely certain that whoever makes up the next governmen they are going to be skint (we run a spending deficit of over 5% after all currently and a similar hole in our import/export balance) its pretty certain that pensions will be tinkered with again since they are:
– 25% tax free
– largely outside of inheritance tax now
So take your pick of what the changes will be:
– lower lifetime allowance (a bit of a sleeper)
– no higher rate tax relief (the big saving)
– charging national insurance on drawdown (another big one)
Right now the current personal pension regime is just a bit too good to last
@Neverland – you’re dead right there. I think it’s the probability of government tinkering that is the reason so many people want to get their money out while the getting is good (including me). Forget the Lamborghini purchase, what are the (is it still New?) Labour party going to do to our pensions? As Mr G Brown showed last time around, they have many causes worthier than pension savers to spend money on. Of course, Mr Brown et al will never have to worry about his pension as he has a marvellous parliamentary DB scheme which is paid for and underwritten by the taxpayers (us).
@all – I appreciate pensions and politics are somewhat entwined, but can we try to stay to likely risks and actions (e.g. Neverland’s list) and probabilities, rather than moving into ad hominem attacks against parties/politicians. That’s not to say I won’t sympathise with some of it, but more I don’t want our threads to become Telegraph/Guardian style political ranting that eventually overwhelm sensible discussion. Perhaps over-cautiously I’ll nip it in the bud and start deleting if we go too far down that path.
Cheers!
Friend of Monevator, Lars Kroijer, had an interesting piece on annuities for the CFA Institute this week. Well worth a read:
http://blogs.cfainstitute.org/investor/2014/10/27/annuities-are-expensive-make-sure-you-need-them/
Weenie – ” not getting too excited about them as they will all no doubt change again by the time I’m in a position to retire”. I understand your thinking on this point, and given the government debt levels its not unforeseeable that the government may help itself to pension pots. However, counterbalancing this is the fact that most people are now auto-enrolled in DC pension schemes, thus in future more people will have a stake (and vote) in ensuring pensions aren’t meddled with.
@L – thanks for the tip, that is a very good and balanced article. Maybe he was planning to recycle it for a monevator post 😉
@ Investor
Politics and investment are totally intertwined
My fav recent example is Russia’s seizure of the Crimeria, within days of the shooting stopping the Kremlin’s allies were moving in and taking the assets owned by Kiev’s oligarchs
In the democratic west we try to hide the facts by citing the “rule of law” but thats just a fig leaf
@Neverland — Perhaps true but countless sites’ comments are ruined by incessant political ranting from all factions. Hence biased to nuke, unless it’s comments on an explicitly political article.
Monevator readers may well be able to accommodate all the nuances of drawdown versus annuities (rpi-linked or otherwise) but do those in places of power of whatever hue seriously think the man on the Clapham Omnibus (or perchance, even woman!) is going to be able, or even want, to involve themselves at that level, even assuming their pot is large enough for them to bother. Seems to me a disaster in the offing, where the dear old taxpayer is going to have to clear up the debris field, assuming the country is not completely bust by then!
Excellent and thought provoking argument by the way but then approaching 60 as I am, the whole thing gives me sleepless nights!
There’s an interesintg (and sober) analysis of where the succession of peions reforms might lead us (even if this weren’t the goal at the outset) by the FT’s Jonathan Eley here (24 October 2014): http://www.ft.com/cms/s/0/3cf3d160-5a8f-11e4-b449-00144feab7de.html#ixzz3Hk76DiWk
Begins: “Does the government have plans to mobilise pension savings for other purposes?
Stop moaning and get on with it. That’s the general reaction when insurers and pension providers raise questions about the pace of reform in the industry, or question the motivation behind it ….”
It seems to me that really there is little to worry about.
According to the Pensions Regulator, the average DC pot size at retirement is £25,000:
http://www.thepensionsregulator.gov.uk/doc-library/dc-trust-a-presentation-of-scheme-return-data-2014.aspx
As stated in the excellent article above, this would buy you an annuity paying an index-linked income of 2.25% at age 55. At 60, 2.3%. And at 65, 3.3%.
That in pound notes is £563pa, £575pa or £825pa. For as long as you live. This income is then liable to be taxed. These figures would be 25% less if you were to take the tax free lump sum at retirement. In other words it will take more than 30 years to be given your own money back. More than 44 years at age 55. You could approximately double this income if you have no indexing. But inflation will affect your standard of living badly as you age. This is why annuities have a bad reputation.
With drawdown the income on £25,000 would probably be similar but the capital may increase or decrease. The one sure thing that I found when I looked into it, the charges would be high for drawdown. When I worked out the effect of the charges on my personal quote (I am 60 and spoke with Standard Life), the pot would run out even before I am projected to (according to an online life expectancy calculator). So drawdown is expensive too.
The new rules enable an individual to have additional choice in how he spends his retirement savings. For example, he could retire at 60, spend £5,000pa knowing that he’ll get his state pension at 65 (or whatever age applies to him/her).
How he/she can end up living on the state is beyond me. If anyone can elucidate I would be obliged.
I apologise if my earlier comments about a previous Chancellor’s taxation of pensions were seen as a rant, I just think we should never forget the dangers of political interference re pensions.
As a Baby Boomer with a good final Salary pension, state pension and investment income, I was advised many years ago to invest in a Stakeholder pension for my wife a non taxpayer and even myself with I have stopped.
It seems the new rules will allow me to either leave these in my estate for my children that have no/poor pensions having to fund expensive London houses and families.
In the event that I need more income I can use the stakeholder pensions to to purchase an annunity or draw it down to allow giving other assets to the children.
So it seems the final benefit is based on the tax position of the beneficiary, my IHT position at the time and if I need more pensionable income. So all this seems good news to me, if I have understood the changes and I will still keep contributing to the stakeholder pension.
So it not all about individual pensions but how pensions can be used to pass assets to children who have little in the way of pension assets. I am thus removing their eventual burden from the state. All this seems to be good news or am I missing something?
@paullypips — No apology required in this instance (thanks!) and very mild anyway as these things go — I was just taking a precautionary stance against escalation.
Small point but I think the numbers quoted for the annuity at 60 are wrong. today the numbers are 228; 2735 ;3347 – the steps are always pretty linear – so I think a typo there – but as there are a number of calculations based on that might want to check and rework.
More fundamentally I absolutely agree with the sentiments that income drawdown is a very useful option; that political interference is always a risk; that the ability of individuals to take stupid decisions will also always exist but that’s no reason to assume no one is capable and that the nanny state has to take all decisions; and that the inheritance situation is a potentially massive benefit to some people – though like another commentator I do wonder what happens when the inherited plus the one already established by the beneficiary exceed the then lifetime allowance? particularly for anyone with enhanced protection or only children inheriting two sipps – this seems a real possibility for (an admittedly fortunate) few.
ha – now I am having number typos – should have read 2289; 2735;3347
The numbers I quoted were on the HL site a couple of weeks back, so there’s no way of checking — I didn’t keep a copy. The numbers you cite are dated Oct 30th, after this article was published.
But yes, the “aged 60” number looks out by £400 or so versus today’s figures, so a typo somewhere looks likely, and the likely culprit is me. In which case, the “aged 60” yield is 2.7%, not 2.3%.
The Greybeard
The best pension to have is a defined-benefit pension, because one can count on the income, it’s guaranteed by somebody else.
An annuity is a defined-benefit pension.
Those who find it astounding that a secure, inlation-proofed income for life at 60 costs £100,000 for £2,700 annually, are badly underestimating the risks involved in drawing down at a higher rate.
Individual drawdown is a profoundly inefficient way of financing an uncertain life expectancy, because it throws away mutual insurance amongst members of the annuity pool.
The later in life one annuitizes, the worse the lifetime yield, because of mortality drag.
Annuities simply don’t deserve the bad press they get. People who call annuities providers “thieves” and “criminals” look to me like they really don’t understand the basics of investment.
I think this article is ill-founded, and doesn’t address the fundamentals of annuities at all. Instead of helpful, rational analysis, we’ve got a pack of baying nutters, emoting about stuff they don’t understand. What a mess.
@Jonathan: 2.7% versus a tracker? With retention of capital? I’ll take the tracker, thanks. Sorry if that makes me baying nutter.
The Greybeard
@Jonathan — Nothing wrong with articulate disagreement, and I agree (as I said above) that annuities have some attractions, even in today’s climate. But please don’t start a slanging match, as I’ll eventually have to delete comments rather than let an unhelpful / abusive row ferment.
Additionally, I think you go too far with your sentiments. Perhaps the article might have included an extra bit highlighting the attractions of annuities, but we have written that before and it’s already a beast in size. This article is focused on the other side of the decision. There’s a reason that annuity sales have collapsed and there’s widespread commentary across the investment sphere that they offer poor value for many compared to the alternatives right now, which recent legislation is addressing.
This article and our readers’ response is hardly an outlier.
As far as I can see drawdown offers a wider set of option permutations for generating income in retirement. There is nothing in any of the recent legislative changes that prohibits annuity as a good alternative in certain situations. Some observations I would make:
1) an appealing alternative like drawdown puts pressure on annuity providers to blow off their cobwebs if they want to survive – never a bad thing in my opinion. 😉 There is nothing worse that a captive market in any sector let alone financial services which hardly has a clean reputation.
2) I have always dreaded the idea of handing over my hard earned pension pot to some annuity provider for life i.e. never be able to correct my mistake if choosing Provider A was a bad/misinformed decision.
3) Hated the idea of residual pension pot gobbled up by a annuity provider when I am gone: I would want my dependents to benefit.
4) People who have saved diligently for retirement would hardly be persuaded to be reckless just because they have greater control over their pension saving. This group would hardly bank on state pension continuing to be a fall-back position for a comfortable life in retirement.
I do agree though that there is huge potential for the rogue advisory service to germinate. I would like to see some proactive fence building by legislators as opposed to doing what they normally do … frantically legislate once a great big fire has taken hold.
I personally cannot wait for the new rules to be fully implemented and bedded down – choice & some level of control is never a bad thing in my opinion. Blind faith nearly always is.
Annuity supporters are always from the industry, ie they have an axe to grind, hardly ever from the pensioners.
I am prepared to concede they can be suitable in a few cases, but they are very few. To have them obligatory for all, is diabolical. The annuity providers should be grateful they had the market to themselves for so long and have exploited it to the hilt and beyond. Perhaps they should not be banned but they should certainly carry a “health warning”.
Buy 10 income unit trusts and live on the natural dividend. switch to better ones when they drop below average in the performance tables 2 years in a row. It is as simple as that.
The “new developments” referred to in your headline do not “tip the balance”, they correct a diabolically unfair law. Stop being so timid and call a spade a spade sometimes.
@Franco — So we have one commentator calling the article outrageously extreme against annuities, and then we have you saying it’s too timid…
And people wonder why they disagree with so much they read in the press…! 😉
Looking at all this is just depressing, and I take 2 things in particular from all this:-
1. Leaving aside the whole issue of the abolition of forced annuitisation (yes yes, we all know that income drawdown was an option for some), if the pensions regulator is saying the average DC pension pot is £25,000 and annuitising this at at 65 will give an annual income of around £800 – £900 or so, then vast swathes of the population are, barring inheritance, lottery wins or a spouse on a non-contributory civil service pension, screwed.
Even if you chose instead to convert that £25,000 into e.g. a HYP portfolio, on current yields of between say 4 / 5%, you’re still looking at a max of £1,250 per annum.
Even adding the state pension onto this (assuming (big if) that’s it’s still around in anything like the current amount) when you come to retire, then, if you don’t already own your own home outright by retirement age and/or have a spouse/partner, with average rents across England & Wales at £761 per month (http://www.thisismoney.co.uk/money/mortgageshome/article-2761202/Rents-reach-record-average-761-month-house-price-rises-push-ownership-reach-swell-demand-lets.html), the state pension and a DC pension pot of £25,000 is barely going to cover rent and Band C/D Council tax. Tough cookies if you’re also wanting to eat and stay warm.
Sure there will be regional variations in rents and people may own their own homes and some may work past the official state retirement age, which will soften the blow for some, but these make for pretty bleak numbers, especially for singles.
2. Following on from 1 as sure as night follows day, this is going to lead to either (i) burgeoning welfare bills to top up “income” for these people, financed by increasingly punitive taxation on those still lucky enough to have a job, or (ii) civil commotion, or (iii) both. In this scenario, anyone who is not “poor” (by whatever definition is used at the time) or a government/local government employee, is ultimately going to face expropriation of their assets to finance the welfare bill. It may start off gently, with reductions in tax reliefs, abolition of tax free lump sums etc etc, but ultimately, you’re looking at state confiscation of private pension pots as these sums are just too tempting for politicians. You only need to look at what has happened in Argentina or, closer to home, Poland, to see what could happen, and your best case scenario will be conversion of your pot to government gilts at a derisory yield.
Given that, as someone alluded to above, the current rules will be seen as amazingly generous and a clear signal to take control of your own cash while you still can.
Interesting article.
Annuity rates aren’t great at the moment as (largely) the fixed interest assets that back them also aren’t doing great. But I think they still have a place. They let you pass on inflation, investment and longevity risk to the insurer, at a premium obviously. They can provide a floor to your income and hopefully rates will get better as interest rates rise! (You could perish the day after you bought them or the insurer could go bust but that’s part of the risk you take on. Nothing should be considered ‘guaranteed’ in totality)
I think that more options can only be a good thing (but maybe only for the financially savvy?).
What you have highlighted well is that regulation changing is a massive unknown that we can’t really plan for until we actually retire!