Retirees should consider a mix of solutions to fund their retirement rather than take a once-only annuity versus income drawdown decision, an investment special report from Aviva recommends.
Aviva’s Making Good Retirement Choices report takes an analytical look at how annuities or income drawdown purchased in 1999, 2004 or 2009 performed, given the specific set of economic conditions, and it fast-forwards to 2014 to see how any residual money could be used. The report found that across the three periods neither annuities nor income drawdown could reliably be predicted to deliver the best outcome.
The analysis throws into question the current focus of establishing a single annuity or income drawdown solution as the most appropriate choice, which has been prompted by the Government’s introduction of greater freedom in how people take their retirement savings.
Aviva’s analysis found that those people choosing income drawdown in 1999 and failing to adjust the investment portfolios used in the analysis would not have made a good decision.
They would find themselves today in a poor financial position compared to having chosen an annuity at outset, regardless of whether the investment was in bonds or equities. A similar analysis for 2004 also favoured the annuity option.
However, in stark contrast people entering drawdown in 2009 have done much better, due to the strong performance of equity markets delivering good results from drawdown in both the 100 percent equity and mixed investment options.
The report concludes that a balanced approach that mixes an annuity and drawdown, whether from a pension fund or other investments, may present the best balance of risk management with potential reward.
Clive Bolton, Aviva’s managing director retirement solutions, said: “Our analysis is a salutary reminder of the need to plan carefully for retirement, taking all possibilities into account. If the past few decades are anything to go by, savers should plan for volatility in the economy when considering how to fund their retirement. “It’s clear that no single product, whether it is an annuity or income drawdown, can offer a cast-iron assurance that it will out-perform all other retirement solutions. For that reason people should take advice where possible, and be realistic about how much money they need for the remainder of their lives. “Increasingly we are likely to see people choosing a mix of solutions that meets a variety of needs over a long retirement, and balances risk management against the desire for the best income.”
Consider an annuity if their retirement savings in total only cover their core planned expenditure. Drawdown may be a viable option if their retirement savings exceed their core expenditure needs. Drawdown works best when the funds that the pension is invested in are rising and when the income withdrawals are not excessive. If choosing drawdown, they should be realistic about the level of income withdrawal chosen. Consider reducing or stopping income withdrawals from drawdown portfolios when the value of the drawdown investments are falling.
Consider mixing annuity and drawdown income, with annuity income covering core expenditure needs and drawdown income covering discretionary spending. Consider the tax consequences before taking their pension pot as cash – a cash pot is very similar to a drawdown pot as a way of providing income. Take financial advice if they do not understand the choices open to them. The analysis is based on the following assumptions: Annuity purchase price is £50,000, based on the 6th April of each respective year, using male rates at age 65 years and assuming the annuity is set up on joint-life level basis. Drawdown amount invested is £50,000, with three portfolios of equity, fixed interest and mixed investment and assuming a portfolio charge of 1 percent, with the amount taken as a withdrawal from the portfolio matching the original monthly annuity income that could have been bought with the same amount of money.