For many years pensioners were faced with the prospect of being forced to cash their pension pots in for an annuity income, but the amount of income you can get has been falling rapidly.
In 2000 someone with £500,000 in pension savings could buy an annuity paying an annual income of £43,350 according to Moneyfacts. That same sum will now get you an income of just £24,850.
While income drawdown was available it was reserved for the rich, with strict rules in place about how much you could take. But that has all changed now.
Pension changes: more choice, but more thought needed
Thanks to the shake up to pensions and the new freedoms that came into effect in April you have a lot more choice about what you can do with your pension pot. You no longer have to buy an annuity and income drawdown is available to everyone. But all this choice means that making the right decision has become a great deal harder.
“The new options brought in this April give you far more flexibility with your pension,” says Richard Harwood, Divisional Director – Financial Planning at Brewin Dolphin. “However, with this flexibility comes the possibility of making the wrong decisions. There is now no guidance on income levels so it is possible to use up all of your fund before you die.
“People may shun annuities because they want to pass on their pension pot on death. But if they live too long there may be nothing to pass on and they may even exhaust the fund before they die.”
So if you have a £500,000 pension pot what would Richard Harwood suggest you do with it? First of all you need to think about more than just your pension savings.
“The role of an adviser is to look at both what a client wants, and what a client needs, so that their real requirements are covered and all risks are fully considered – even the ones the client did not expect. Such as the risk of living too long!”
Best to consider all of your finances
As part of this, Harwood recommends considering all your assets and savings, not just your pension, when planning your retirement income. For example: “A client who has other investments available to them could find that the tax applying to their pension fund on death could be lower than the inheritance tax on other assets in their estate. They may well be best served by accessing other funds for income in retirement and preserving their pension pot.”
Alternatively, if your pension is your main income source for the rest of your life, income drawdown may not be the best choice. “For them the risk of exhausting their fund could be too high,” says Harwood. “Although it may be out of fashion to purchase an annuity, doing so with at least part of the fund could still be the best thing.”
If we assume for the sake of income drawdown that the £500,000 fund grows at 5% per annum, with an annual management charge of 1.5% and inflation at 2%, then that fund could provide an annual income of £20,000 for 28 years. But if you increase that to £30,000 it would run out in 12 years if the income increased with inflation.
The sensible route is therefore to speak to an adviser and take a complete approach to all your assets. It may be you can go for income drawdown, or you could be better off spending other assets and leaving your pension alone, or it could be you buy an annuity with part of your pot.
“It is a matter of balance. The first priority has to be to provide for sustainable income throughout your entire life. If that can be done then you can enjoy the benefit of the flexibility available,” concludes Harwood.
The value of your investment can fall and you may get back less than you invested.
All information is for illustrative purposes only and is not intended as investment advice; no investment is suitable in all cases and if you have any doubts as to an investment’s suitability then you should contact us or your financial adviser. Any tax allowances or thresholds mentioned are based on personal circumstances and current legislation which is subject to change.
The opinions expressed in this publication are not necessarily the views held throughout the Brewin Dolphin Group.