Annuity Advice UK: About annuities
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Please do not solely use the information below when choosing an annuity. Refer all questions to your consultant.
INCOME DRAWDOWN
You can choose income draw-down as an alternative to an immediate annuity purchase, if you are aged between 50 and 74.
With this arrangement, you should first take your tax-free cash element, (it cannot be taken later), and the balance remains in your selected pension fund. You can now draw down a chosen amount of between 0% and 120% of the calculated single person's annuity value for the remaining fund. The residual fund can be converted into an annuity when you choose to end the income draw-down arrangement.
Income draw-down is definitely not a suitable option for all. It is essential that any individual obtains the appropriate level of advice before committing to this course of action.
Listed below are outlines of the potential advantages and more importantly, the disadvantages generally applicable to income draw-down, to help your appreciation of this retirement option.
The advantages of income draw-down
You can vary the amount of income - After deciding on the level of tax-free cash to take from your pension fund, the balance is invested. From this balance you select an initial income level between 35% and 100% of the amount that would be payable had you taken a single person's annuity. The on-going value of your fund will depend upon the level of income taken and the rate of investment return on the remaining fund.
Getting a higher income - income draw-down allows you to maximise your early income because it is based on the equivalent single life annuity. With a conventional annuity, with extra features, such as surviving spouse benefits, the annuity income would be at a lower value. Your spouse is still protected with draw-down (see 'death benefits' below).
Death benefits - with a standard annuity, payments cease at the death of the annuitant, (unless you have opted for extra benefits that can be bought within these plans such as spouse pension and guarantee periods). If death occurs during income draw-down, the remaining fund is not lost. There are three options available :-
The remaining fund can be paid as a lump sum (subject to a 35% tax charge),or
the surviving spouse can continue to use income draw-down, or
the remaining fund can be used to buy an annuity for the surviving spouse.
Thus income draw-down provides significant benefits that are not available with a conventional annuity.
Possibility of increased income - Your money is still invested in a retirement fund, so, if the investment returns are high, the fund value will benefit. This could therefore generate a higher annuity income, when the fund is finally converted. Annuity rates do also increase with age, due to life expectancy reductions.
Benefit of deferment, if annuity rates are low - When you purchase an annuity, the rate of return on the investment (and therefore your income) is fixed at the date of purchase. By using income draw-down you can defer your annuity purchase to a more favourable time. This could be appropriate if annuity rates were expected to rise in the future.
Age at annuity purchase - the annuity rate increases with the age of the applicant, for a given fund value, due to reduced life expectancy of older people. So a 10 year delay in annuity purchase would increase the annuity value.
Disadvantages of income drawdown
Fund charges - your money remains invested , and the fund-holder will continue to apply charges for fund management. This does not apply to an annuity investment.
Investment risk - if the fund's investment returns fall below a certain level, then the amount of continuing income available under income draw-down will fall. Also when an annuity is finally purchased, the annuity income could be lower.
Lower Annuity Rates - if annuity rates fall, the amount available to calculate draw-down, and any future annuity income would be reduced. This would apply even if the pension fund's investment strategy were relatively successful.
In summary, key issues are :-
High income withdrawals may not be sustainable during the deferral period, forcing a reduction in income levels.
Taking income withdrawals may erode the capital value of your fund, especially if poor investment returns are combined with high income levels. This could result in reduced income when the annuity is eventually purchased.
Investment returns may be less than those shown in any illustration provided.
Annuity rates may be at a worse level when purchased than they are now, leading to a reduction in income.
Income draw-down can be a valuable retirement planning tool under certain circumstances for particular fund-holders.
This is a complex area and it is recommend that you take expert advice. Your consultant would be delighted to assist you in reaching an informed decision about income draw-down.
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