Andrew Megson from My Pension Expert explains the difference between an annuity pension and a flexible-access drawdown at a time of high insecurity.
You do not need to search long for evidence of the cost-of-living crisis.
Indeed, inflation has soared to a 30-year high of . Elsewhere, grocery inflation was reported to have hit in April, the fastest rise since December 2011. Obviously, all of this will place unprecedented strain on Britons as they struggle to regain control of their day-to-day finances.
And the struggle for retirees is no different. Without a monthly salary, many will be concerned about their ability to maintain their financial health.
This will, of course, be a worrying time. Luckily, however, retirement finance products are available that can help retirees regain control of their situation.
Throughout times of uncertainty, most individuals crave stability. And this can be offered to retirees in the form of an annuity.
Annuities are sources of retirement income that can be bought with part, or all, of a person’s pension pot. This purchase guarantees the purchaser a fixed income for the rest of their life. Alternatively, it can secure income for a set period of time if the retiree takes out a fixed-term annuity.
Adding to the potential attraction of annuities is the fact that annuity rates – the rates which determine how much an individual will receive for their pension – have risen to the highest level in three years to . This means that retirees are likely to receive a more generous income for their pension.
The security of a guaranteed income – particularly when there is scope to receive a higher return for one’s pension – will certainly appeal to some retirees through times of economic volatility. After all, in theory, purchasing an annuity protects the value of their pension from fluctuating with market volatility.
That said, annuities can be inflexible products, which may not benefit retirees in the long term.
Whilst theoretically a secure product, annuities are highly inflexible. Indeed, once an individual agrees to purchase one at a fixed rate, they are locked in for the rest of their life – or for the pre-agreed period. Whilst this means that their income will remain the same throughout volatile economic periods, it also means that the annuity rate will rise with inflation. This could leave retirees struggling with the cost of living despite having a regular source of income.
Further, the portion of the retiree’s pension used to buy the annuity has no further opportunity to grow – once the purchasing process is completed, it’s gone. Again, this could result in financial difficulty later down the line.
With this in mind, perhaps some retirees may be better suited to a flexible–access drawdown. This product enables retirees to take control of their own retirement income, dictating exactly how much they choose to withdraw and when. So, for example, a person can choose to withdraw slightly less during periods of high inflation to ensure their pot is not emptied too quickly.
Better yet, the product offers the potential for the person’s pension to continue growing. This is because, whatever a person does not withdraw remains invested within their pension fund, leaving the potential for the value of the pot to continue increasing throughout their retirement years.
It must be noted, however, that this will mean that the value of an individual’s pot may fluctuate with market volatility. Indeed, this may be concerning for some individuals. Yet, given that it means that retirees will also benefit from positive market changes, it is certainly possible to understand the attraction of this product.
So should you choose an annuity or a flexible-access drawdown?
Of course, the answer is not clear cut; after all, there is no one-size-fits-all approach to retirement finances. Every individual’s retirement income solution will depend on several factors, including their existing financial situation, future goals and risk appetite.
As such, it would be wise for savers to seek independent financial advice before making any final decisions. An adviser will be able to assess all the aforementioned factors and make tailored recommendations to suit their clients’ specific needs and help them secure the best possible retirement outcome. In some cases, they may think an annuity might be the best option. In other cases, it might be a flexible access drawdown.
These are strange and uncertain times for many retirees. Luckily, however, there are options available to them to help them maintain financial stability through this testing time. The key is to seek independent financial advice before choosing a new product. In doing so, they will be able to maintain control of their finances without hindering the future of their retirement.
*Andrew Megson is the Executive Chairman of My Pension Expert, an Advised Retirement Income Specialist. Founded in 2010, My Pension Expert specialises in providing independent advice to UK consumers about their pension plans – it arranges millions of pounds worth of retirement income options each week.