In pledging to keep interest rates low, Bank of England Governor, Mark Carney hasn’t helped people wanting to buy an Annuity
As You Approach 55 Or If You’re Older, The Annuity Issue Is Possibly The Most Important Financial Decision You Will Have To Make
Annuity rates, which are considerably lower now than in the recent past, are unlikely to rise in the foreseeable future. It’s therefore not surprising that in a recent survey of financial advisers by insurer MetLife UK, 42 per cent of advisers said their clients were asking about alternatives to Annuities.
Despite very poor returns, buying an Annuity still remains the most popular choice for people reaching retirement, compared to other options. The Annuity market is fierce, evidenced by the fact that Tesco and Virgin have recently introduced comparison services.
Why Have Tesco And Virgin Entered The Annuity Market?
That's simple. Because there’s money to be made. So an old cynic like me suggests that if they intend to make money, it can only come from one source. Your pension fund! And for that reason, you need to understand what's happens to your money.
Buying an Annuity tends to be the default option presented by a pension provider to someone who wants to draw their benefits. But is it the best choice? A clue, perhaps, can be found in the survey.
Most people buy an Annuity, often without consulting an adviser. Yet financial advisers said their number one choice for their own retirement is Income Drawdown.
Instead of handing over your whole fund in exchange for an Annuity, with Income Drawdown, you retain ownership and control of your fund, and draw an income from it. Even more telling is this.
Dominic Grinstead, managing director of MetLife UK, said: “It is striking that just one in 10 advisers themselves would rely on a conventional or enhanced annuity for their own retirement income in current market conditions.”
When So Many People Are Buying An Annuity, Why Are Those In The Know Choosing Income Drawdown?
A quick look at some numbers could reveal the answer. The following is taken from an analysis carried out earlier this month for Geoff, aged 70 who isn’t in perfect health, and his wife who’s 67.
Compared to average stockmarket performance, 6.8% appears to be a good result. It would have outperformed every sector over the last five years, as you can see in this article entitled A Secret To Growing Your Pension.
The problem is that Geoff’s income is fixed for life. Over time, inflation will erode its real value, leaving him with less and less money as time passes. Geoff could choose an Annuity that increases throughout his retirement, but he’ll start off receiving a significantly lower income.
Instead of buying an Annuity, Geoff could select Income Drawdown. He could leave his money invested in the stockmarket, but that might continue to earn him less than he'd receive from an Annuity. To boost his income, he could lend his money to one of the high earning loan notes found on SIPPclub, Like This One Which Earns 12% To 15%.
The amount of income Geoff can draw under Income Drawdown is similar to his Annuity rate. This means he won’t be able to draw out all of the interest earned on the loan note. This is a good thing. It means the balance of the interest will remain invested, increasing the value of his fund, tax free. At a later date, he could increase his income as his fund will be greater. And as he’ll be older too, the amount he can withdraw will have increased.
There’s Another Advantage Of Income Drawdown
If your pension fund is in Income Drawdown when you die, HMRC will clobber it with a tax charge of 55%. Whilst that might seem penal, I prefer to look at it more positively. 45% of your pension fund is available to those you leave behind.
With an annuity, they don’t get a penny of your pension fund. That remains with the insurance company in return for paying your retirement income. Often that stops the day you die, though your Estate may receive the balance of a guaranteed period of payment, and your spouse might be entitled to an income.
How Does This Affect Geoff?
If Geoff selects Income Drawdown and the above loan note, and takes an income equivalent to an Annuity which he doesn’t increase, if he and his wife die after 15 years, their children could collect £206,609.
That’s £206,609 More Than Their Children Would Get If Geoff Buys An Annuity
It's previous obvious there are very good reasons why financial advisers favour Income Drawdown. Geoff’s figures bear testimony to it. So don’t just do what the pension providers and the Annuity comparison services would like you to do, for that clearly earns them a lot of money.
As Theo Paphitis often made reference to on Dragons’ Den, you really could be risking your children’s inheritance!
So Which Is Best – Annuity Or Income Drawdown?
Unfortunately, there isn’t a simple answer.
On the face of the figures, Income Drawdown appears to win hands down. But with an Annuity, your income is secure. It'll be paid to you for at least the rest of your life no matter how long you live. And it's not affected in any way by market performance. As people get older, they often want a simple life, and you certainly get that with an Annuity.
With Income Drawdown, however, you have to keep tabs on your money on a regular basis, including regular reviews. That will involve time and money.
So which one is better depends entirely on your personal circumstances and your requirements. It’s like everything to do with pensions. You should always seek full and detailed advice from a specialist independent pension expert.
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AJ Bell Is Often The Best Value SIPP For Stockmarket Assets
Over time, charges can wipe out a huge part of your fund. We like AJ Bell because there are no set-up costs. If you hold passive funds, which is our preference, or shares, investment trusts, EFTs, gilts or bonds, you pay one small fixed fee no matter how large your fund. And when you come to draw your benefits either as occasional drawdown or UFPLS payments, there's a small charge for the whole year no matter how many times you access your money (many SIPP and SSAS providers charge more than this for each payment). However, you should always compare charges in detail, because AJ Bell could be more expensive than other providers, depending on the type of stockmarket assets you hold.
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As SIPPclub neither advises on, nor arranges, nor recommends specific investments or strategies, we're unable to say whether a SIPP or SSAS or any investment within it is right for you. Ultimately, it’s your money and your decision, and you should only proceed once you're satisfied you've undertaken sufficient due diligence. If you need advice, you should speak to your trusted adviser, or you could find a local adviser from Unbiased.co.uk. Alternatively, we'd be pleased to introduce to a suitably qualified independent financial adviser.
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Notes: Research by MetLife conducted online between 25 March 2013 and 2 April 2013 among a representative sample of 287 financial advisers. Annuity rate provided by the Annuity Line on 15 August 2013, including an ill-health enhancement, a five year guarantee and a 50% widows pension. A children's inheritance figure above is calculated without reference to SIPP operator charges.