Why you need advice when you access your pension fund

Working out your pension options means making some big decisions with long-lasting consequences.

But people about to retire are making one of the biggest decisions on their future without taking advice, a study has found – a move which could leave them short of cash in later years or without an income at all.

The Financial Conduct Authority said in its report that people were accessing their pension pots early without taking advice, taking the “path of least resistance” and opting directly for the “drawdown” option to give them an income.

So what are your choices?

Income drawdown is one of two main options – along with buying an annuity.

An annuity is a financial product you buy with a lump sum from your pension savings which pays you a guaranteed regular income, usually for the rest of your life. There are different types, some continuing to pay your partner if you die. Once you buy an annuity you can’t change your mind, so you are advised to talk to an expert to help you make the right decisions. 

For example, Eric is a fit and healthy 60-year-old with a £150,000 pension fund. He takes £30,000 tax-free at the outset which leaves £120,000 to be invested in an annuity. He secures an annuity for life of £5,399/year at a rate of 4.5% (although deals and rates vary) and he'll get this until he dies.

Income drawdown is where your pension fund is invested, from which you can cash in part of the fund on a regular basis as your income. You should explore your options with a financial adviser, as it is not as safe as an annuity, relying on the stock market. You have the flexibility to tailor your income to different phases of your retirement, for instance, you might want to withdraw a bigger income in their first few years of retirement when fit and healthy than you might require in your 80s and 90s. It could prove more profitable if the markets do well, and there could be savings left to pass on when you die.

Eric’s cousin Ernie is also 60 and is fit and well, and has opted for the income drawdown option to provide for his future. He also takes £30,000 of his £150,000 pension pot up-front tax-free and invests the remaining £120,000. For his projection** he chose a “moderate” risk portfolio with 10% in cash accounts, 40% securing fixed interest and 50% on the stock market, paying him £5,399 a year (the same as his cousin) with a 4% growth to cover inflation. The projection (which assumes “middle” investment growth) estimates he’ll run out of money after year 27 of retirement as he has drawn on the fund and his capital each year. However, if he had died before then, he would have been able to pass what was left in the investments to his family, unlike with the annuity option.

Either option supplements whatever State Pension you have earned. But which is best for you?

Retired council officer Mike Williams from Mapperley, Nottingham, said: “You have to protect your future as best you can, balancing one-off spending with the long-term.

“You might need a lump sum in retirement, for private medical care or home improvements.

“My worry would be running out of money, so I chose an annuity while keeping some of my savings accessible in ISAs. No one knows how long they are going to live but if you take an annuity you have the certainty of knowing the pension will last as long as you need it.

“You used to have to buy an annuity but not any more, which is why you have to take advice. If you took out a straightforward one and died within 12 months that would be all you or your family would get. There are products which would care for your wife or partner if that happened.”

So your big decision when you retire is between buying an annuity or investing your pension pot to gradually withdraw the money when you need it. But which is right for you? You need to take advice.

Annuity versus drawdown

So you might choose an annuity to be sure of:
  • Certainty and a guaranteed income for the rest of your life; 
  • Protecting your retirement income from stock market fluctuations; 
  • Keeping your income rising with inflation. 
But an annuity might not be for you if…
  • You want the flexibility to change your mind on your pension options; 
  • You have a short life expectancy; 
  • You want to keep your money invested and accessible; 
  • You’re on your own and want to leave some pension savings for your family when you die; 
  • You think annuity rates might rise – and that it could be worth waiting. 
Income drawdown could be your choice if you want:
  • Flexibility to take money out as and when you want; 
  • Different amounts of income each year;
  • Your money invested in the markets.
But you might decide against income drawdown because:
  • You feel your investments might not last your lifetime; 
  • You’d be happier with a guaranteed income each year; 
  • You’re uncomfortable with investment risk in retirement. 
Financial adviser Steve Hudson, from our trusted partner Wren Sterling said: “In some cases drawdown is more appropriate – especially where flexibility of income levels and leaving a legacy are concerned. However, for some clients annuities remain the most appropriate option.

“Clients need to be aware there are risks associated with drawdown. In a drawdown plan a client could ultimately run out of funds and therefore find themselves without income later in life. This could be as a result of withdrawing an unsustainable level of income, poor investment returns or both. 

“However, an annuity income is guaranteed to continue for the remainder of a client’s life and can be written on a joint life basis to guarantee a lifelong income for both the pensioner and a spouse, partner or any other chosen beneficiary.”

An independent financial adviser can: 
  • Work out your particular goals and objectives; 
  • Review your current arrangements; 
  • Factor in planned or expected changes in the future; 
  • Take into account your various savings, investments and pension arrangements;
  • Make recommendations to suit the short, medium and longer term.
Your independent financial adviser can research the entire market place to find the most attractive drawdown or annuity rate, and in some cases to arrange an enhanced annuity, paying a higher level of income if the client has health issues. You can arrange an initial consultation at one of our branches at no cost to you.

* Annuity calculation through Age Partnership.
** Drawdown projection through Which?

Annuity versus drawdown

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