Yesterday I was a millionaire, today I’m living on £22,000 a year
For a 65 year old non-smoker male in good health, looking to purchase a conventional, inflation linked annuity including a 50% spouse’s benefit, £1M will buy him approximately £22,200 per annum (source: IRESS Exchange). Would you buy?
The biggest fear for pensioners is running out of money – outliving their income. So how can you generate a sustainable pension income?
The Annuity Route
Buy an annuity. There is no less expensive way of guaranteeing an income for life and they can be more attractive if you qualify for “enhanced” annuity rates due to lifestyle or health issues. That said, more people are eschewing annuities because of loss of access to the capital (an annuity is irreversible); the thought that early death causes a huge loss (though this is the premise of annuitising – those who die early subsidise those who live longer); the fact that an annuity leaves no legacy and annuity rates are at a historical low as the above example illustrates all too well.
The Investment Pot Route
Leave your pot invested and take an annual withdrawal based on your future longevity each year. This is a common approach in the USA and does indeed guarantee some income for life. It also means your pension pot remains invested so has the potential to grow. The main disadvantages are the income is variable; there is investment risk to the fund and, as your future life expectancy decreases as you age, the proportion of the fund withdrawn each year becomes larger, depleting your pot faster resulting in lower withdrawals later in life.
The Insurance Route
Buy longevity insurance. Unfortunately not yet available in the UK (but I anticipate it will be) this is in essence a deferred annuity. You pay a lump sum when you retire which produces a guaranteed income at a future point in time (the deferred date), if you are still alive of course! The balance of your pot then only has to last until the deferred date, which is easier to plan for. The cost of this insurance is significantly lower than a lifetime annuity leaving you flexibility, control and potentially a legacy.
The Natural Income Route
Take the natural income produced from an invested pension pot. Such an approach means you won’t outlive your pot, but as the capital remains untouched (though it will fluctuate in value, as will the income it generates) the level of income is correspondingly reduced. A legacy will be available and could well be the right approach if sufficient other (guaranteed) income is available.
Other approaches exist but, as I am sure you can now appreciate, planning is key. In the words of one of the world’s renowned investors, Warren Buffet, “Someone’s sitting in the shade today because someone planted a tree a long time ago.”
Author: Paul Newton FPFS, CertPFS (DM & Securities), STEP Affiliate, CertPMI is a Chartered Financial Planner for Castlegate Financial Management Limited, a firm of Independent Financial Advisers, authorised and regulated by the Financial Conduct Authority. 8 Castlegate Grantham Lincolnshire. 01476 591022. This article is for information purposes only and does not constitute financial advice which should be sought before any action taken. The value of investments and the income from them can fall as well as rise and is not guaranteed which means you could get back less than you invest. Past performance is not a guide to future performance.