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Pension pots and how to survive them

Research from Cass Business School finds that annuitising at retirement is not the best option

Most people would be better off drawing down money from their pension pot when they retire rather than annuitising, according to research from Cass Business School.

The paper, Pension Pots and How to Survive Them, by Cass Faculty of Actuarial Science Academics Professor Les Mayhew, Dr David Smith and Dr Douglas Wright, was launched today at the International Longevity Centre UK in London.

In 2014 the UK Government announced proposals to allow people to withdraw money from their pension pot from age 55, subject to their marginal rate of income tax in that year. This paper looks at how individuals can best use their pension pots.

The research finds that with careful management, moderate sized pension pots of £100,000 or more should not run out until at least the age of 80 or even older. Using a flexible rather than fixed drawdown approach can reduce the risk of running out still further.

The research recommends having a full financial ‘health check’ at the point of decision, and if drawdown is decided upon then the research recommends seeking regular independent professional advice thereafter.

The main reasons for these conclusions are that:

  • People are living longer. Annuity rates are at an historic low and the forecast is for this to continue
    If you die young the annuity dies with you and so you risk wasting your money by annuitising too early. To some extent this risk can be offset if you are eligible for an impaired annuity resulting from ill health
  • Protection against inflation is expensive and so most people choose a level annuity whose value erodes with time and may be worth little at old ages
  • People with small pensions pots will only receive a small annuity anyway but could also find that their benefit entitlement is reduced (e.g. if their only other income is their state pension)
  • People with large pension pots should always draw down, but those with intermediate pots (around £100,000) have the most difficult decisions to make as there are various trade-offs to consider
  • People owning property and whose pot is running out should consider equity release either in the form of a lump sum or regular payments or by downsizing. Depending on one’s circumstances this could give better value as well as retaining flexibility (e.g. to bequeath)
  • As long as drawdown is done carefully (e.g. by not taking out too much at a time), tax planning is more efficient and flexible
  • Using the tax free element of the pot to increase one’s state pension entitlement is better value than buying an open market annuity because rates of return are higher and income is inflation proofed.
  • For the vast majority there is not enough money in pension pots both to pay for long term care and have a sufficient day-to-day income. People will need to rely on other assets such as their home or on means tested state support.

Lead author, Professor of Statistics, Les Mayhew said:

“The new freedoms are exciting but need not be especially risky. If simple rules are followed people should benefit from the greater flexibility, whether it is making intergenerational transfers or simply better enjoying their retirement. It is important that your pot is invested appropriately according to your preferred level of risk and is also managed professionally.”

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