Last week, the Financial Conduct Authority (FCA), the regulator, released a report that echoed what we’ve been saying for some time: if you don’t want to be ripped off, you need to make sure you shop around carefully if you plan to buy an annuity (a lifetime income stream that you buy with your pension pot).
The FCA says that eight out of ten people who simply buy an annuity from their pension provider, and four out of ten overall, miss out on better deals.
The money involved is not trivial by any means: the FCA calculates that the average sum you lose by getting a bad deal is equivalent to having an extra £1,500 of savings. Worst of all, the situation is particularly bad for the most vulnerable – those with smaller pots (less than £5,000), who are ignored by most providers.
Indeed, the situation is so bad that, instead of trying to attack the report’s main conclusions, the industry has accepted its central premise.
An alternative to buying an annuity is simply to keep your pension invested and draw down a certain amount each year – hence the name, income drawdown. Ideally, the returns on your pension investments compensate for the money you’re withdrawing. Another benefit is that when you die some of your money can be left to relatives.
It is also a much more flexible option. While buying an annuity is an irreversable, one-off decision, if you opt for income drawdown, you can change your mind later if you decide you want to buy an annuity after all.
There are some risks to be aware of with income drawdown. The biggest is that the value of your pension pot could go down, especially if you invest it in high-risk investments. Similarly, if you take too much money out, the value of your pot could quickly dwindle, hitting future income.
This is why the government limits the amount that you can withdraw, based on a formula that takes account of your age and the yield on 15-year government bonds (although if you can prove that you have a secure income of £20,000 a year already, you can take as much as you like, via flexible drawdown).
A possible compromise is to buy an annuity big enough to cover your basic expenses, but leave the rest to draw down. So if the stock market did badly, you wouldn’t be left to rely on the state pension. Of course, this route relies again on shopping around.
On that front, the FCA found the vast majority of brokers it spoke to were breaching its rules to some extent, so don’t rely on just one broker. And make sure that if you have any health problems that you make it known – it’ll mean you get a bigger annuity.
• Ed Bowsher has shot a video tutorial explaining how to get the best value from your retirement pot – take a look at it here: How to get the best annuity