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Annuity V Drawdown
Annuity v Drawdown, interesting? But hardly the FA cup!

The current economic conditions make considering your retirement options even more difficult than 5 years ago. Even then, these once in a life time decisions were far from easy to make.

So why is it more difficult today?

The effect of the global financial crisis has driven down interest rates to an all-time low. The Government's Quantitative Easing (QE) together with the downgrading of many European countries' sovereign debt has increased the value of our own Gilts. The result is that the yield to maturity (return available) on Gilts has fallen to historic low levels. Annuity rates are generally determined by the yield on Gilts with 10 years to maturity.

Add to that the continued increase in life longevity and the European rules on gender equality, together these factors have pushed down the returns now available on annuities.

The Government has also taken away the requirement to buy an annuity at age 75, especially favouring people with a Pension drawdown plan. This has resulted in fewer annuities being bought as investors are hoping their families may benefit from the improved death benefits in drawdown.

If you are looking soon to make your final retirement choices, we would recommend that you seek advice including completing an appetite for Investment risk questionnaire before making your choices.

Understand the changes before you act!

If you add to that the creation of flexible drawdown, which allows people with a fixed income of £12,000 to withdraw their pension pot without ever buying an annuity, this has further reduced the funds being invested in annuities.

Continued changes to the level of income that can be taken from a Pension Drawdown plan doesn't make matters simpler.

In 2010, after being elected, the coalition Government reduced the maximum income that can be taken from a Pension Drawdown plan from 120% of what an annuity could provide to just 100%. This was aimed at reducing erosion to the pension capital in the hope that pensioners would be less likely to become dependent on the state in the future.

  This would also have assisted people in drawdown to maintain their income for longer with improved chances of having a rising income in retirement; however, this reduction of income allowance coincided with the worst economic downturn in living memory. When combined with reduced annuity rates attributable to QE, the lowering of the income drawdown levels caused many pensioners to struggle against their increased cost of living.

As a result, the 120% of annuity income level for Pension Drawdown was reinstated at the end of March 2013 and increased further to 150% in the 2014 budget. Many see this as a victory for pensioners and in the short term they will be able to increase their income making life easier financially.

In the mid to long term [5-15 years] this may lead to an opposite effect. Therefore choosing the right level of income from a pension drawdown in relation to your investment risk profile has become more important than ever before.

At the moment Pension Drawdown requires a 5 year plan anniversary review to ensure that the income being drawn remains sustainable over the long term. This could result in a drop of income in the future if the value of the Pension fund has fallen due to capital erosion.

If all the proposed changes come to fruition it may be possible for pensioners to run their pension pot down to zero long before their life has ended. We would advocate caution here as pensioners have not fared well on the whole from over reliance on the state. Making large pension withdrawals of 150% of the annuity rate with the intention to spend the income would have seen many pension income drawdown schemes destroyed during the 'Credit Crunch' leaving many pensioners worse off than they are today.One of the great benefits of a SIPP is that when changes are made to the pension products, they are usually retro-fitted. This means that you can benefit from positive changes; however the opposite is also possible and there is no guaranteed that 100% of an annuity income won't return in the future.

Many annuitants are choosing to look at drawdown and phased drawdown to avoid buying an annuity during this period of low interest rates in the hope that they will get a better deal once rates rise.
There is of course no guarantee that this will be the case and investors with a pension pot of £100,000 after taking the Pension commencement lump sum [Tax free cash] should seek professional advice before committing to an annuity for the rest of their lives.

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