Pension myths, misconceptions and the occasional informed commentEvery so often a newspaper prints a financial story which really captures the imagination of their readers.

Last Saturday such a story was published in the Telegraph under the dramatic headline: “Government made me squander £66,000 on rotten pension.”

You can read the full story by clicking here but it involved a Mr Miles who is in his 60’s and now regrets buying an Annuity with his pension fund, whilst bemoaning the fact that the new ‘Pensions Freedom’ won’t apply to him.

There is no denying that Mr Miles suffered a series of unfortunate events, although he would have been well aware of the risks before selecting the initial Income Drawdown plan. However, the story itself, as well as the subsequent reader comments, only serves to confirm some of the pension myths which stubbornly refuse to go away.

We’ve taken some of the lines from the story, as well as the comments and given the ‘other side of the story’.

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“But in a cruel twist, inflexible pension rules forced him in 2011 to do the one thing he knew would be financially disastrous: spend his pension pot on an Annuity.”

A combination of volatile investment markets, Government policy and low gilt yields all combined to cut the maximum income Mr Miles could take from his pension pot. But this was only temporary, at his next mandatory review, in three years’ time, the situation could well have improved.

It is clear though, that Mr Miles felt forced by the circumstances  he found himself in, to buy an Annuity.

However, this raises an important issue. Many people still believe they will be forced to buy an Annuity when they retire; this isn’t the case. The requirement to buy an Annuity was abolished a number of years ago; absolutely no one is “forced” by law to buy an Annuity.

Furthermore, the case of Mr Miles highlights one of the key risks with Income Drawdown; it probably isn’t for you if you can’t cope with a reduction in the income it produces.

“But in his case the changes come too late. It is on account of people such as Mr Miles that The Daily Telegraph is campaigning for the Government, regulators and insurers to develop some way of “reversing” or “cashing in” Annuities for policyholders in certain circumstances. These would include savers forced to buy Annuities in recent years when rates were at their lowest ever levels, as well as those people sold inappropriate Annuities by insurers.”

Did we mention that no one has had to buy an Annuity now for a number of years? Of course we did! Although we do accept that some people feel compelled by their circumstances, or indeed a lack of information, to buy an Annuity.

However, the article does make an important point. Many people who have bought an Annuity from their existing pension provider could have done better, especially if they have not shopped around, or indeed looked into the possibility of an Enhanced Annuity due to health or lifestyle problems.

If you are considering an Annuity, look at other options, shop around for the best rate and look into whether or not you qualify for an Enhanced Annuity.

“Annuities are a big fraud. Mine started paying me an annual amount when I was sixty-five and I won’t see any profit from it until I’m eighty-six. If I’m lucky enough to survive until eighty-seven I might see a bit of profit. Otherwise the company I started paying into when I was thirty have seen a nice big gravy train with my cash. If I had known then what I have come to realise now I could have saved that money myself and it would have earned considerable interest.”

Where to start with this?

  • 21 years for this pensioner to “make a profit” on his Annuity is an awfully long time. It indicates to us that the Annuity rate he or she secured isn’t competitive
  • This is backed up by the fact that the Annuity was bought from the same provider he or she held their pension with
  • An Annuity is effectively longevity insurance, which pays an income no matter how long you live. If however you die earlier than expected the Annuity provider doesn’t pocket the cash, it benefits the ‘Annuity pool’ which includes some people who will live far longer than expected
  • Savings accounts, which pay interest, are not the answer. Interest on savings accounts is generally below inflation, guaranteeing a real terms loss. What’s more, current savings rates are certainly below Annuity rates

“Ooops! Plonker should have placed his money in property instead. £100,000 invested in a buy to let rental would have offered far better returns.”

The amount of money Mr Miles could take out of his pension was capped, making it impossible to take all of the money out and invest in a buy to let property.

However, from April next year the new ‘Pensions Freedom’ rules will allow people to take their entire pension pot and invest in a buy to let property if they wish. But there are huge downsides, including a potentially large tax bill. It’s also debatable whether the yield from a buy to let is actually better than the potential returns from a pension.

We’ve written more about the downsides of taking money out of a pension to invest in buy to let, which you can read by clicking here.

“No risks at all by moving the fund to a Self-Invested Personal Pension and investing in high yielding blue chips like GSK, Shell, BAT and Vodafone.”

This statement is simply untrue and very dangerous.

Investing in stocks and shares carries significant risk; not only could the dividend be cut, but the share price could fall, reducing the value of the overall investment if it ever needed to be sold.

“People have a choice: buy an Annuity and be safe, or go for Drawdown and hope for better returns but live with the risk that they may not achieve them. You cannot have it both ways.”

To a degree this is correct, but it doesn’t tell the whole story.

Pensioners don’t have to make a black and white decision: Annuity or Income Drawdown. For many people a combination of the two might work well; with the Annuity (perhaps along with a State Pension) providing a guaranteed income to cover essential outgoings and Income Drawdown to give added flexibility and cover discretionary spending which may change from year to year.

Everyone’s situation is different, which makes advice invaluable. However, for many people a combination of products could work well.

“I’m afraid I have to agree with some of the other comments…he drew down too heavy and too young.”

It’s hard to say whether or not this is the case with Mr Miles. However, for anyone contemplating taking advantage of ‘Pensions Freedom’ it’s an important point.

Taking too much out, too early, could mean your pension ‘dies’ before you do, leaving you unable to meet your outgoings in old age.

Assessing how much you can take out of your pension each year, without running out of money before you and your spouse die, will be one of the big challenges presented by ‘Pensions Freedom’.

“We don’t know what future interest rates will be …but his Annuity actually looks good value to me at 6.76%”

There’s no denying that Annuity rates have fallen over recent years, mainly due to lower gilt yields and the fact we are all living longer.

But everything is relative. A 6.76% per year return, even though it will remain level and won’t rise with inflation, does look attractive compared to current interest rates on savings accounts. What’s more, the return needed from an Income Drawdown plan after charges are taken into account, to match the income provided by the Annuity, would probably be above 7% or perhaps even 8%.

That’s a tough ask for most investment portfolios and would require a significant degree of risk to be taken.

We’re here to help

If you are concerned about making the right decisions with your pension pot, we’re here to help.

Whether you are approaching retirement or have already retired and are using Income Drawdown, we are here to help.

Call one of our retirement experts today for an initial chat on 0115 933 8433, alternatively complete our online enquiry form which you can find by clicking here.

 

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