A ‘guaranteed’ pension income is highly-prized by retired people who no longer rely on employment to provide for them.
The problem is that guarantees are expensive to secure.
An annuity is the traditional way for those in retirement to turn their pension savings into guaranteed income. The deal is that they hand over a pot of money and the annuity provider will guarantee a level of income for the rest of their life.
The products have fallen out of favour for many people since the introduction in 2015 of new rules allowing access to pension savings more flexibly. Since then, many have preferred the flexibility of a ‘ drawdown’ arrangement that leaves their pot invested to generate returns and provide an income. Drawdown income may well rival, or exceed, annuity income and can be passed on in the event of death, but it is not guaranteed like an annuity is.
Thankfully, you don’t have to choose just one and can mix the two options together. What’s more, there could be benefits of doing this that go beyond simply adding extra peace of mind by increasing your guaranteed income.
New research this week claimed that a balance of annuity and drawdown income, when combined with some cash savings and the state pension that most of us can rely on, can not only raise the level of guaranteed income you enjoy but also increase your chances that your invested pension money lasts to be passed on after death.
Actuaries Milliman imagined the case of a 65-year-old with a pension pot of £100,000 who needed an income worth 4% of their fund, rising with inflation. They applied two possible retirement plans. The first split their pot into 5% cash, 55% equity and 40% in bonds, while the second substituted out the 40% bonds for a level annuity.
Milliman ran the two retirement plans alongside one another in 1,000 hypothetical scenarios to see how likely it was for each of them to deliver the target income. By combining an annuity with an equity drawdown fund, the research claims, they would increase the likelihood of maintaining their target income until age 100 from 45% to 55%, compared to a drawdown fund investing in equity and bonds.
Put another way, the annuity/equity plan meant it was more likely that there would be money left towards the end of retirement which is then available to be passed on after death or for increasing income in late retirement. Additionally, the higher level of guaranteed income from the annuity provided a bigger safety net in periods when the plan failed to generate the required income. In other words, the bad years were less bad.
Underneath the headline findings were some interesting counterpoints. For example, the annuity/equity plan became more advantageous the longer it ran but trailed the bond/equity plan if retirement lasted less than 25 years.
If a person did live longer, though, there were also sizeable benefits from the equity/annuity plan in terms of the money they could pass on. After about 21 years of retirement, the average death benefit left from the equity/annuity plan began to overtake the equity/bond plan. The difference got bigger as retirement lasted longer, until the difference in average death benefits reached more than £20,000 after 34 years of retirement.
What does all this mean for those thinking about their own plans?
It is important to say that modelling like this, while interesting, is hypothetical and the results are influenced by many variables that depend on individual circumstances - no one is completely average.
What works on paper may not work in the real world. You may not care to have a higher income in very old age, preferring to spend your money sooner, or perhaps you’re unconcerned that there’ll be nothing left once you die.
The exercise does show, however, the value of thinking long term about your retirement finances. Do you want to maximise income early and live on less later? Do you want to pass money on? How much would it concern you if your level of income changed from year to year? Does your health mean you can look forward to a long retirement, or not?
There’s plenty of places to get help answering these questions. The Government offers a free and impartial guidance service to help you understand your options at retirement. This is available via the web, telephone or face-to-face through government approved organisations, such as The Pensions Advisory Service and the Citizens Advice Bureau. You can find out more by going to pensionwise.gov.uk or by calling Pension Wise on 0800 138 3944.
Fidelity’s Retirement Service also has a team of specialists who can provide you with free guidance to help you with your decisions. They can also provide advice and help you select products though this will have a charge.
Read more about options for accessing your pension money here.
The value of investments and the income from them can go down as well as up, so you may get back less than you invest. Tax treatment depends on individual circumstances and all tax rules may change in the future. Withdrawals from a pension product will not be possible until you reach age 55. This information is not a personal recommendation for any particular investment. If you are unsure about the suitability of an investment you should speak to an authorised financial adviser.