Pensions and Isas Special Report
Older savers on the verge of retirement have a new world of choice on how they draw an income from their retirement fund. This is thanks to new freedoms designed to let over-55s have unfettered access to their money, which were introduced in April.
These freedoms aren’t working for everyone as millions of people are being blocked from getting flexible access to their pensions – as this newspaper has highlighted in our Make Pension Freedoms Work campaign.
But despite this the changes have had positive effects. Before the changes, it was commonplace for retirees to feel forced into buying a guaranteed income for life, in the form of an annuity. A reliable income may be attractive, but many of these deals were poor value — and annuity rates are now close to an all-time low.
But more people now also have the option to leave money invested, giving them the potential for higher returns, and the ability to take cash when they need it. This is known as “drawdown”.
How you choose to live off your pension is one of the biggest financial decisions you’ll make. But if you are agonising over whether to buy an annuity or use drawdown, you can relax. It’s perfectly possible to have both. And a growing number of people are choosing to adopt this strategy. Here we outline how splitting your pension pot in two could work, as well as the investment strategies that you could use to grow your money.
Why should you split a pension in two — and can you afford to?
By choosing drawdown alongside an annuity you would combine the security of a lifetime income with the risk and potential for higher returns from drawdown. But according to David Penny, an adviser at Somerset-based Invest Southwest, there is no “magic number” when it comes to whether a pension saver can use a mix of annuities and drawdown.
One rule of thumb is to calculate how much you need each month for bills and how much will be covered by your state pension. Then use an annuity to top up the rest of your basic income requirement. The rest can go into drawdown.
If the end result is that you can only afford to put £50,000 of your pension money towards drawdown then you should consider a different option.
This is because some pension firms insist on a minimum investment of £50,000 for drawdown. In any case, experts say the income generated via drawdown on pots of £50,000 or less will
only amount to a couple of thousand pounds, which will be reduced further by the selfinvested personal pension (Sipp) and fund charges, which typically amount to over 1pc. The next step is to decide what you would like to achieve with the remainder of your pension portfolio. Financial advisers say investors who mix and match can afford extra investment risk — given that they have secured their essential income via an annuity.
But with today’s savers expected to spend far longer retired than their predecessors, they should spread their risk across a range of asset classes. It’s important to diversify by investing in a mix of assets such as shares, bonds and property to keep the pension pot growing in retirement. We asked financial adviser firms Cockburn Lucas and Invest Southwest to come up with different models for pension savers with different goals and tolerance for risk: To achieve this you should invest around 60pc in shares, as shown in the first chart on the previous page. Bonds play a smaller part, at 28pc, because returns are too low. Our experts suggested buying specialist funds that prioritise income. Options include Schroder Income Maximiser (yielding 7pc) and Fidelity Enhanced Income (6.2pc). The funds use a complex, but effective strategy. In effect, the manager sells investors’ rights to some future capital growth in return for cash, which boosts the “natural” income from the assets. Savers who want an annuity-like income and worry about their capital depleting should aim for 4pc income. As the second chart shows, 40pc of the pot should be in shares and 45pc in bonds. For the equities part, Laith Khalaf of Hargreaves Lansdown suggests Marlborough Multi-Cap Income (4.1pc), Woodford Equity Income (3.5pc) and Newton Global Income (3.5pc). If you don’t intend to spend your pot you can afford to take a higher risk, with 70pc in shares. With a 30-year timespan Mr Penny says he would recommend a similar strategy to someone in their midthirties who has just started saving for retirement. “This scenario is where I believe the pension revolution is likely to have an impact on children,” he said. “Currently suffering under the weight of student loans, and the need to generate a deposit on a property, this generation can be massively advantaged by responsible parents and grandparents bequeathing these funds entirely tax-free.’’ Kenneth Orwin, from Morecambe, was a scaffolder before retiring this year, and wants to enjoy a comfortable but modest retirement, including one or two holidays a year with his wife Diane. He has a Sipp worth £130,000, and £26,000 in a workplace pension. He hopes this will provide an income of £5,000 a year, £4,000 of which will go on basic living costs.
Mr Orwin says: “I like the idea of securing living expenses through the annuity while investing the rest because I want the freedom to dip into the pot when I wish.” Mr Penny suggests taking out a £70,000 joint annuity with 50pc spouse’s benefit on death. This would give £3,990 a year guaranteed income while they are both alive.
He said: “If they are happy to take risk, they could use their 25pc tax-free lump sum (worth £32,500) to invest their full Isa limit now. The remaining £53,500 of pension could be invested in drawdown.
“Isa and drawdown can be reasonably expected to pay 4pc a year, £3,440, bringing total annual income to £7,430, comparing well with the best full annuity, which would provide £4,639 via Legal & General.”