Is this pension the best of both worlds?
First published 23 November 2015 • Updated 23 January 2017
If you’re retiring soon, you face a tricky choice about how to access your pension. Do you fancy flexible, or do you prefer to play safe? You don’t necessarily have to take one option over the other, because a third way is growing in popularity: guaranteed drawdown.
Retirement? Stress free? Pull the other one. Right away it throws at you one of the biggest decisions of your life: how to use your life savings to support you for the rest of your life. And now we’ve said ‘life’ too many times. That’s how stressful this is.
On the face of it, there appear to be two main options for taking your pension: an annuity, or a drawdown scheme. An annuity provides a lifelong guaranteed income (though this may not be very much), whereas drawdown allows you to take as much as you like from your pot each year (but with the very real risk of running out of money). The trouble is, both options involve big unknown. Drawdown can be best, IF the stock market performs really well. An annuity can be best, IF you live a really long time. It’s just hard, if not impossible, to predict what will happen.
Does this leave you with a dilemma? Not necessarily. Because there is a way to hedge your bets.
The third way: guaranteed drawdown
Guaranteed drawdown isn’t a new concept, but its profile has risen a lot since George Osborne gave us more choice about how to take our pensions. More interest in it means more competition, so we can expect to see new guaranteed drawdown products entering the market. Here’s an overview.
What is it?
Guaranteed drawdown is similar to an annuity, in that it provides you with a regular income for life. However, the pot of money remains invested, so you can draw on more money if you need it.
Sounds too good to be true.
Of course, there are limitations. What you receive is a guaranteed minimum income, which is fixed for life so long as you don’t exceed it. If you do draw out more money than this, then your guaranteed income in subsequent years may be lowered by a proportionate amount.
So how is that different from ordinary drawdown?
It’s different for two big reasons. Firstly, even if you do take more than your minimum, you’ll still have a guaranteed income in later years, though admittedly a lower one. Secondly, your guaranteed income is unaffected by poor fund performance. Even if a stock market crash reduced your fund to zero, you’d still have your guaranteed minimum income for the rest of your life.
And it’s different from an annuity because…?
An annuity won’t let you take out more money than your fixed income. Guaranteed drawdown is potentially very useful if you can foresee some times where you might need extra money, above and beyond your regular income.
But if I exceed the minimum, the guaranteed amount will fall?
That’s right. But the idea is that people shouldn’t regularly exceed their minimum, but only do so in special circumstances. A few instances shouldn’t deplete the guaranteed amount too much, but you should take financial advice on this issue so you know exactly what you’re doing and what the consequences would be.
Can the guaranteed income ever rise?
Yes it can – if the invested funds perform well, then this should be reflected in a higher guaranteed minimum income. Poor performance, on the other hand, will not reduce your guaranteed income – only excessive withdrawals can do that.
Any other drawbacks I should know about?
The guaranteed income you receive won’t be as high as an annuity bought for the same money, because of the additional flexibility it provides. Also, do remember that your minimum income can fall if you overspend, so don’t be misled by the word ‘guaranteed’ – it comes with those conditions.
If guaranteed drawdown sounds good to you, then you should talk to a financial adviser about it. An independent adviser can tell you more about how it works and whether it will meet your needs, and can also recommend the best products currently available from the whole of the market.
However, before you do that, you can find out the current state of your pension pot with a free pension check from an adviser near you.