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Money matters: a new retiree needs your help

Income drawdown or annuity

In a new column, we’re asking you, the Which? Conversation community, to help answer people’s financial queries. This month, it’s what to do with your pension pot when you retire.

You’ve got two choices for converting your pension savings into an income that’ll last through your retirement. But making the right choice can be tricky.

In general, most people will choose an annuity. This is a financial product that will assess your age and health, then calculate and pay you a guaranteed income until you die.

But what if you want the potential to grow your money even more, and have some flexibility with how much you take each year? Well, that’s where an income drawdown comes in.

Drawdown allows you to leave your money invested in the stock market, while you take an income from it. You can take a maximum of 120% of what you would have got from an annuity, so you have the opportunity to take a lot more income when you need it the most.

What advice would you give?

A Which? member wrote to us recently asking about income drawdown:

‘I’m 60 and have a small self-invested personal pension (Sipp) worth about £15,000. I would like to take income drawdown from this fund, but all the adverts I’ve seen refer to a minimum pot of £50,000.

‘Is there any way I can do this? What are the tax implications?’

Can you help a fellow reader find a solution to his pension quagmire? Do you think it’s worth entering into a drawdown scheme given how much he has in his savings?

We’ll be posting our own answer at the end of the week, but in the meantime, we’d love to hear your views and experiences.


In the informative Which? notes on alternatives to annuities [follow the “income drawdown . . .” link in the article above] there is the following comment : “Because of what’s at stake, income drawdown is only suitable if you have a large pension fund, and preferably some other income”. Personally, I would heed that advice. If I was thinking of dancing on the high wire I would certainly want both a safety net and a landing mat. Annuities have their drawbacks, particularly the difficulty in selecting the best yield for a long time ahead, but the certainty that they will pay out until death provides considerable peace of mind which has a value all its own. If only we could accurately calculate our life expectancy, our personal financial needs and the future rate of inflation! The article does not say whether the Which? member has already retired; where it is possible and health permits, there is a lot to be said for postponing retirement in order to carry on building up financial resiilience and security. Because pension fund contributions generally attract tax relief the government seriously constrains deployment of the accumulated pot and expects to maximise the collection of revenue from the eventual returns.

Bob says:
2 April 2013

About £15,000 in Invesco Perpetual “Monthly Income plus Income” currently produces £90-100 per month.The return is about 6% in an ISA. For me, its important not to let my money be held from me should I need it at any time in the future. Having said this, I have no idea of the income paid from an annuity of £15k. But I would be unhappy to let my savings rest in the hands of others permanently, given the history re pension pots and tax changes.

At current rates a £15,000 fund at age 60, after taking a 25% tax-free lump sum, would purchase a level single-life annuity paying around £42 per month.

If you estimate that an annuity pays around 5% of the fund value you won’t be too far out. Of course, this is not the same as an investment giving a 5% return, as the annuity rate includes a large element of capital return

Another rough guideline is that you need to live to around age 86 to break even on an annuity.

A Self Invested Personal Pension from which you can draw income has the attractions that it may grow in value, depending upon the assets it is invested in – including equities, funds, bonds – and it does not die with you – it can be passed on to your heirs. If you can administer it yourself you avoid some charges, but if you use, for example, an Independent Financial Adviser then their charges may be an excessive proportion of the income from a small pot.
For security, if all you have is small pension pot and a state pension, then the annuity seems the safe choice. But reports that annuity providers take 20% or more in profit from your annuity really bothers me.
That is my take, as a layman, on the situation.

Is this a trick question or have we not been presented with all the necessary information?

On the given facts of the case, the Which? member’s only pension benefit (apart from State Pension entitlement) is a Sipp fund worth c. £15,000.

So why are they not able to cash-in the entire pension fund from age 60 under the Trivial Commutation rules? Why is the choice of options in this conversation being limited to annuity or drawdown?

If, in fact, there are other occupational or personal pensions that would prevent this, then we still do not have all the necessary information on which to express a sensible opinion. For instance, they could have other secure pension income which means the 120% cap on annual drawdown is not even applicable.

Hi Gareth,

Thanks for the reply.

Then assuming there are no other pension benefits (other than a future State Pension entitlement) – and crucially there is no other taxable income to take into consideration that we are unaware of – I would first look at Trivial Commutation rather than income drawdown. That way, the entire fund less a small tax charge of around £360 becomes available.

Having removed the fund from an approved pension scheme, it is no longer subject to future management charges or government tinkering with drawdown rules and actuarial rates. Hopefully, the pensioner will have the good sense to place it in low risk investments (Building Society bonds, etc.) rather than blow it all on a world cruise, but of course that becomes entirely their choice. And assuming they are male and have no other income to live on until they turn 65, the availability of a £15,000 lump sum could be very handy to help cover those initial years of retirement when the level of income drawdown or an annuity would be nowhere near enough to bridge the gap.

But for all we know, this person could have some taxable income from employment or other investments. In which case I would instead encourage them to defer materialising their Sipp pension benefits and try to save more money into the fund. Even without any eligible income, it is possible to add £2880 per year net from savings, which is grossed up to £3600 – effectively a subsidy from HMRC.

Assuming they could sustain this level of contribution for 5 years, their Sipp fund would then be worth more like £33,000, a level at which an annuity purchase becomes more viable in terms of value for money (about 6% better return compared to a fund size of £15,000 at today’s rates). It is also possible that the current dire annuity rates will improve over time, if the government would stop messing with the gilt market.

Without understanding their current or future tax position, or eligibility for state benefits until retirement, this is just speculation about possible options. We don’t know anything about the health of the person, so whether an enhanced annuity would be available, we cannot say. But given the current or even potential size of the Sipp fund, I think the benefits of drawdown over annuity purchase are almost non-existent.

For me, the certainty of a modest annuity income for life outweighs the possibility of exhausting my drawdown fund, should I live long enough. And the idea that one could somehow take this modest fund and make a substantial amount of income from this point onwards by keeping the fund invested is just wishful thinking. The time to take investment risks is when the pension fund is being built up, not after drawdown commences and the capital remaining to invest initially diminishes and then starts rapidly converging to zero.

The only exception would be if I had other secured pension income of £20,000+ and could use the flexible drawdown rules to take unlimited amounts from the Sipp fund as and when I need them for exceptional expenses.

So, on the facts available and in order of preference:

1) Trivial Commutation

2) Try to continue making Sipp contributions at a tax-efficient level and purchase an (enhanced?) annuity with the increase fund

3) Flexible drawdown

Income drawdown on a fund of this size? Forget it unless there is some mitigating circumstance we are unaware of.

@chris.legg – I find the advice you have been given slightly confusing. This is my understanding:

Money left in a SIPP fund can be willed to Beneficiaries, subject to a 55% tax charge. Note this is not Inheritance Tax, as the SIPP fund is not a part of your estate and therefore no threshold. 55% is payable on the total amount of the remaining SIPP fund

The SIPP fund can be passed to your spouse (or other dependant), who can continue to take income drawdown or even flexible drawdown depending on their other sources of pension income. She is not obliged to by a pension annuity.

However, if she does buy a pension (annuity) with the residual SIPP fund, there is no SIPP fund left to pass on to the children, so there can be no tax charge.

With regard to whether a Basic Rate taxpayer should invest in a pension or ISA, it is a close call.

What you have forgotten in your £20 relief in / £20 tax out example, is that 25% of the SIPP can be taken as a tax-free lump sum, so it is more like £20 relief / £15 tax. It is also possible, depending on State and other pension entitlements, that you, or your spouse after your death, may become a non-taxpayer after retirement. Also, your SIPP fund will have had the benefit of the higher capital sum to invest, so investment gains (or losses!) will be 20% greater than in an equivalent ISA product.

It is also possible that HMRC may again meddle with tax rates, making it very difficult to do any long-term retirement planning!

I was interested in Gareth’s comment, a couple of paragraphs above, relating to income drawdown:
“On the tax issue, anything you take, over your personal tax-free allowance, from drawdown is deemed to be income, and taxed at 20%, 40% or 45%, depending on your tax bracket. On death, remaining funds can be paid to your beneficiaries after 55% tax ”
Only yesterday some advisers at a well known firm told me that any remaining capital in an income drawdown pension could be left as part of my estate. I assumed therefore that it would attract 40% tax after allowances – why 55% ?

I’ve since looked at the notes of my meeting yesterday and see that an income drawdown pension is viewed as a way of preserving some completely untaxed capital to pass on after death. I feel very confused as this is quite the opposite to the 55% mentioned here.