How will you turn pension savings into retirement income? Of all the questions that people approaching retirement have to answer this is among the most important.
For those with savings held inside pensions - either within personal pensions or workplace schemes - there are two popular methods of turning this money into a regular income: annuities and drawdown.
There’s a full breakdown of your retirement income options here.
An annuity is a product that turns pension savings into guaranteed income. The deal is that you hand over a pot of money and an annuity provider will pay an agreed level of income for the rest of your life. Drawdown - sometimes called flexible retirement income - leaves your money invested instead, with an income generated by investment returns, dividends and interest from bonds.
Each method has benefits and drawbacks. Annuities offer income that is guaranteed, no matter what markets do, but the money you use to purchase an annuity no longer belongs to you. Money invested in drawdown, on the other hand, is still yours but the income you get depends on investment returns, so can fluctuate - it is not guaranteed.
Thankfully, you don’t have to choose one or the other - you can have both. Here’s a few things to consider when planning how you could use both annuities and drawdown to turn pension savings into retirement income.
What income do they pay?
For comparison purposes, it’s useful to think about retirement income in terms of the cash income you could expect for every £100,000 of pension savings.
According to current annuity rates, a 65-year-old with no relevant health issues would be able to buy an annuity that pays just £2,733 a year, rising with inflation. That money is then guaranteed.
In drawdown, it is up to you how much income to take each year but taking too much means your savings will run out too soon. Setting a level of income that is sustainable is not an exact science because the level you take may have to change over time as the value and income generated by your drawdown pot changes.
However, Fidelity’s research suggests that a 65-year-old man with £100,000 of savings would produce between £4,500 and £4,700 of income in the first year of retirement, with this level of income being sustainable in nine out of ten 25-year scenarios. After this first year, income would have to be adjusted to take account of changes in the value of the fund.
Annuity for your essential costs
Even if you are happy to take some investment risk in drawdown you might still value some guaranteed income so that you know your essential bills are covered in retirement. Using part of your pension to purchase an annuity can help achieve this peace of mind.
Try to work out what you think your essential spending in retirement will be - housing costs, utilities, food and a budget for other costs like travel and clothing that you’re bound to incur.
Compare these costs to the income you know you can rely on - State Pension, money from Defined Benefit pensions that you know will be paid and perhaps assets such as rental property. If these sources don’t cover your expected essential spending, consider using your pension savings to buy an annuity that will cover the rest.
By only annuitizing enough to cover essential spending, you can invest the remainder of your pension savings with an eye on growth, knowing that your costs are covered if you need to let investments recover for a period.
Buy an annuity - but not straightaway
The rates that annuities pay are calculated using an assumption of how long you will live. If the provider believes you will live a long time after purchasing an annuity, the rate it pays will be lower. For this reason, you will be able to generate a higher income from an annuity if you buy it at an older age.
Also, by delaying an annuity purchase it is more likely that adverse health conditions will be taken into account. Just as annuity companies calculate rates based on your age they also calculate based on your health, and those with health conditions may be able to get a higher rate.
If you do wait before buying an annuity you will have to rely more on invested pension money in those first years of retirement, but this is often the time when retirees are best equipped to cope with the extra uncertainty. The very old may not easily be able to adapt their lifestyle to cope with periods of lower income, whereas younger retirees can. Early retirement is also the time many retirees feel willing and able to earn money through part-time or casual work.
Get some help
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.
Important Information: 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. Investors should note that the views expressed may no longer be current and may have already been acted upon. 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.
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