Despite the introduction of ‘Pensions Freedom’ in April, the most popular way of turning a pension pot into an income remains an Annuity or Income Drawdown.
Whilst an Annuity is guaranteed to pay an income for the rest of your life, and possibly to your spouse to if this option is selected, new research, by MGM Advantage, shows that someone using Income Drawdown, who takes an income equal to that which they could have bought with an Annuity, has a 50 / 50 chance of seeing the money in their pot run out before they die.
MGM Advantage looked at an example where a man aged 65 with a £100,000 pension pot, which could have bought an Annuity of £6,069 per year. If the same man used Income Drawdown, took the same amount of income as was available from the Annuity and generated an investment return of 5% after charges, he would have a 49% of living until he was 92 when the money would have run out.
If investment returns are poor, generating just 1% a year after charges, the man has a 57% chance of his pension pot running out before he dies.
Andrew Tully, Pensions Technical Director at MGM Advantage, commented: “With the new pension freedoms, the choices at retirement will get a whole lot more complicated. There is a lot of talk about using drawdown, but retirees need to be made aware there is a real risk that their money could run out early.”
“While many people may think they won’t live long enough to worry about their money running out, the statistics show this is not true. Healthy people approaching 65 have a 70% chance of being alive at age 86, which is average life expectancy, and a 50% chance of living to 92. That’s like flipping a coin to find out if they will run out of money in retirement.” (Source: MGM Advantage)
A combined solution?
Many experts are concerned about the possibility of pensioners running out of money and believe more people should consider a combined solution, where expenditure is broken down into essential and discretionary spending.
The essential spending is then met from guaranteed income; often a combination of State Pension and an Annuity with part of a pension pot.
The remaining money in the pension pot is then placed into an Income Drawdown arrangement, with the pensioner retaining the flexibility to alter the amount they withdraw based on the level of their discretionary expenditure.
Andrew Tully again: “Most people want to secure a sustainable income that’s guaranteed to pay the bills, which is where a blending approach comes, in using an annuity to pay the bills and then using drawdown or other options for spare cash. This is both tax-efficient and sensible from a planning and peace-of-mind perspective.”
“Financial advisers have been promoting this sort of approach for years, but I am concerned that in the shake-up of the pensions market, people will not access advice and therefore may make poor choices.”
Of course this is only one solution and until the needs of an individual have been carefully assessed it is not possible to ascertain the exact course of action which will be correct.
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