Most of my friends commenting on the issue of what we do with the pension pot are from the DB occupational world – drawing or managing the pension drawdown for people who have a default way forward. Typically this involves taking tax free cash on offer and then a reduced pension. There may be some choice about flexing increases or appointment of survivors to pick up pensions but for most people, the need to take advice is limited and that is why I think people like pensions.The key is that you trust what is going on and if you’ve got trustees who you trust, then you have a system that works.
But many people aren’t in the lucky position of having a promise fulfilled. They need to make their own decisions and most probably with the help of an adviser. If you can find a good one, pay her or him. I have some close friends who I trust. I trust the people at Retirement Line to provide a good view of annuity choices , I trust Al Rush who is straight about what you can do when you have chosen to leave a DB pension, I have my friend Billy Burrows who provides help to people like me who need organising ( I would be there if I didn’t think about this all the time.
So here is my friend Mr Billy Burrows with his thought’s on pensions and guarantees. I don’t agree with him because I value pensions as a means to keep your money invested (and adding value) while annuities benefit insurers and provide credit (which isn’t investment – in my book. But we are otherwise on the same table. Please spend some of this cold Sunday morning and come to your conclusion.
Is an annuity a pension? – from Billy Burrows blog
That is the question!
Henry Tapper, for those who don’t know him, is probably the most influential commentator and thinker about pensions and writes an influential blog called AgeWage: Making your money work as hard as you do | “one of ten websites and blogs every investor should bookmark”- The Times.
In a blog today, Why do people look forwards to pensions but not annuities? he started an interesting conversation about whether an annuity is a pension.
Henry clearly does not think so, but as with many things, the question and answer are more nuanced.
From my understanding, Henry’s gripe is with his pension provider referring to an annuity as being a pension as set out in the following paragraph – “You ask what I want for my DC pension pot and for my DB pension which I get from a very good former employer. The answer is simple- I want a pension and not an annuity and I don’t want confusion with the phrase “pension annuity” which is being promoted to me by my personal pension plan provider – L&G.”
Perhaps I am missing the point, but an annuity is a pension. However, it is not just a play on words but I think we can say that a pension plan does not have to result in an annuity, but an annuity is a pension.
In my defence, I refer to two important points:
- What actually is a pension?
- What do many people really want in terms of retirement income?
What actually is a pension?
Interestingly, the Government website says “Private pension schemes are ways for you or your employer to save money for later in your life.” This is interesting because it does not refer to a pension as being an income in retirement.
However, the Cambridge Dictionary defines a pension as “a sum of money paid regularly to a person who has retired (= stopped working because of having reached a certain age)”. While Wikipedia writes – A pension (from Latin pensiō ‘payment’) is a fund into which amounts are paid regularly during an individual’s working career, and from which periodic payments are made to support the person’s retirement from work.
My view is that a pension is a regular income throughout retirement but a pension scheme / plan is a thing of two halves: the saving half and the payout half.
let’s call this a score draw! We are both right because the definition of a pension is elastic – a pension does not have to be an annuity, but an annuity is a pension.
What do many people really want in terms of retirement income?
The quick answer is that many people don’t actually know when they first retire so many want their cake and eat: a regular secure income but flexibility and control and the option to leave money to their family after their death.
A deeper analysis suggests that people are faced with a choice between maximising lifetime income without taking undue risks and having the flexibility and control over how they take cash and income from their pensions. The former is an annuity and the latter is pension drawdown.
In terms of the debate about annuities, the mistake is to think that pension drawdown maximises retirement income. It might do, but there is a real risk that it will not provide the same amount of income as an annuity, especially at time of relatively high bond yields.
I look at the matter in a different way. As an adviser, I have an open mind about whether annuities are better than drawdown. We simply don’t know and it all depends on future investment returns and personal circumstances. As an adviser, I focus on objectives: what do clients what to and achieve in retirement and how much risk do they want / can take?
Often the matter is brought into sharp focus when I say: “I don’t want to put words into your mouth but you are probably looking for:
- A sustainable income for the rest of your, and your partner’s life
- To keep pace with inflation
- Without taking undue risks
- With as much flexibility and control as is prudent
When you unpack this, this is neither an annuity (because there is no flexibility or control) or drawdown (because it is not necessarily sustainable income without taking undue risks), it is a combination of each option. This combination may change over time and a prudent person will derisk (annuitize) as they get older.
So, in the final analysis, an annuity is a pension, but people don’t have to have all their pension eggs in one basket.
About the author
William Burrows
William has been involved with retirement options for nearly 30 years, advising clients on all aspects of annuities and retirement income options.
He is a regulated adviser with Eadon & Co He has have many years of practical experience in advising clients about all aspects of pension options at retirement and he is passionate about helping people make the right decisions about their pensions and retirement income.
William also publishes guides including the popular ‘You and Your Pension Pot’ and ‘The Retirement Journey’.
He is frequently quoted in the national press and appears on radio, podcasts and videos and writes extensively on retirement income matters.
Interesting debate here. I have a slightly different perspective from both Henry and William. My perspective is also reflected in what I am doing. This perspective is one born of being fortunate in having enough money for my retirement and I recognise that many people do not have this. My current approach is to be invested 75 :25 in Equities: property whilst also benefitting from a moderate (but insufficient) DB pension scheme. And the state pension! So I am using drawdown to supplement an inadequate DB pension. This came about by deploying the following principles and beliefs
There is no such thing as risk free for DC funds. An annuity runs the risk of being annihilated by inflation and a significant risk that the main beneficiary will be the insurance company. A drawdown fund in equities risks volatility and history would suggest it could suddenly drop by 30% in any one year. However history also suggests that the equity fund will make some recovery from a big drop. I also hold the view that if there is a permanent market meltdown much bigger than 30% then insurance companies may have difficulty paying the annuities. (They would never admit that). So for me I think it is impossible to avoid risk and it is not how much risk I am prepared to take but the best way of managing that risk.
We are all investors whether we want it or not. I understand (from this blog) that Henry wants an income in retirement and does not want to be an investor. But I came to the view that what ever I do the do the money is “Invested” somewhere. For those of us lucky enough to have enough money a good IFA is invaluable. The problem I had was finding one who was focused on my well being rather than focused on extracting a lot of money from my funds. Eventually we did find such a person. But we met many who did not meet this test.
I also subscribe to the Bill Perkins life philosophy of “Die with Zero”. Which would be better expressed as “maximise your life experiences” (but that is not as headline grabbing). It is my view that An annuity guarantees I die with zero but does not allow me to maximise my life experiences or support my children. I do not want to leave a lot of money for my children, but have worked out ways to support them now (when they need it). Equally charitable giving is best done now rather than in my will.
So in summary I think we are stuck with being investors. Annuities provide profit for insurance companies and remove flexibility but still carry risk. Risk is unavoidable. The right answer for each person rather depends on having a view about what you want to achieve and mapping out what is possible.
Thanks Chris- we know each other and I imagine we are in the same place. I don’t disagree with anything you say though I would say that you (unlike me) can do this for yourself.
I want to stay invested but in an investment that has some upside. I am working on that idea with Pension SuperHaven and if any other pensions want to offer staff a pension – I’d be happy to talk with them!
I very much agree that “charitable giving is best done now rather than in my will”, although you can do both.
Giving is its own reward, but it’s nicer to be around still to see what’s being done with it.
The “living” donations may also be topped up with gift aid in the circumstances you describe, Chris.
I will be very interested to learn about any new products, especially if you influenced them. Since the other part of my approach that is important is to review and be flexible as life changes, and products and services evolve
Let’s talk
Pensions, by their nature, are long-term investments, often overlooked due to a lack of engagement. Many people only begin to pay closer attention to their pensions when retirement becomes an imminent reality.
In April 2024, the lifetime allowance was abolished and replaced by two new tax-free allowances:
1. A lump sum allowance, which governs lifetime lump sums.
2. A combined allowance, which applies to both lifetime lump sums and death benefit lump sums.
For most individuals, tax-free lump sums will remain capped at 25% of their fund value, up to a maximum of £268,275. The new combined lifetime and death benefits allowance is set at £1,073,100, matching the outgoing lifetime allowance. Any lump sums exceeding these limits will be taxed at the recipient’s marginal rate of income tax.
The term “pension” is often described in the U.S. as “deferred compensation.” Upon retirement, individuals may access a tax-free allowance (currently 25% up to £268,275) equivalent to their annual personal income tax allowance. (currently £12,570)
In theory, if one could live on half their salary and save the rest, and if those savings kept pace with inflation, they might accumulate enough to ensure financial stability post-retirement. However, inflation erodes savings over time, making this difficult to achieve. Consequently, most individuals achieve only a “career average” income in retirement or less when they start too late.
Very few advisers apply different risk profiles to a fund of which some capital is required for immediate use and other capital will be there for 40 years. Do you not find this odd? In my 50 years of advising 30 year pots could reasonably achieve 5% plus RPI with most risk swapped out. My own fund achieved a Age Wage Score of 100. QED.
The government’s cynical decision to fix allowances and refrain from indexing them is a form of fiscal drag, eroding the value of these allowances over time. Guarantees on old with profit policies and differed annuities I was told recently do not exist by regulation yet they are in COBS 9 to be cosidered.
Discussions with annuity providers reveal a lack of consideration for the benefits of purchased life annuities funded by the tax-free lump sum. Such annuities could provide a more tax-efficient and sustainable income in retirement by leveraging the capital element to maximize net spendable income.
Finally, many retirees overlook the possibility of investing their tax-free lump sum into a tax-efficient vehicle, such as an ISA portfolio where income drawn is entirely tax-exempt.
Exploring such strategies could significantly improve financial outcomes in retirement.
Is the blog updated today?
Looks ok at this end!
The earlier message where I used dictation into word and then cut and paste has still not appeared from before 9 am it is now 9:49
Pensions, by their nature, are long-term investments, often overlooked due to a lack of engagement. Many people only begin to pay closer attention to their pensions when retirement becomes an imminent reality.
In April 2024, the lifetime allowance was abolished and replaced by two new tax-free allowances:
1. A lump sum allowance, which governs lifetime lump sums.
2. A combined allowance, which applies to both lifetime lump sums and death benefit lump sums.
For most individuals, tax-free lump sums will remain capped at 25% of their fund value, up to a maximum of £268,275. The new combined lifetime and death benefits allowance is set at £1,073,100, matching the outgoing lifetime allowance. Any lump sums exceeding these limits will be taxed at the recipient’s marginal rate of income tax.
The term “pension” is often described in the U.S. as “deferred compensation.” Upon retirement, individuals may access a tax-free allowance (currently 25% up to £268,275) equivalent to their annual personal income tax allowance. (currently £12,570)
In theory, if one could live on half their salary and save the rest, and if those savings kept pace with inflation, they might accumulate enough to ensure financial stability post-retirement. However, inflation erodes savings over time, making this difficult to achieve. Consequently, most individuals achieve only a “career average” income in retirement.
Very few advisers apply different risk profiles to a fund of which some capital is required for immediate use and other capital will be there for 40 years. Do you not find this odd? In my 50 years of advising 30 year pots could reasonably achieve 5% plus RPI with most risk swapped out. My own fund has an Age Wage score of 100 QED.
The government’s cynical decision to fix allowances and refrain from indexing them is a form of fiscal drag, eroding the value of these allowances over time. Guarantees on old with profit policies and differed annuities I was told recently do not exist by regulation yet they are in COBS 9.
Discussions with annuity providers reveal a lack of consideration for the benefits of purchased life annuities funded by the tax-free lump sum. Such annuities could provide a more tax-efficient and sustainable income in retirement by leveraging the capital element to maximize net spendable income.
Finally, many retirees overlook the possibility of investing their tax-free lump sum into a tax-efficient vehicle, such as an ISA portfolio where income drawn is entirely tax-exempt. Exploring such strategies could significantly improve financial outcomes in retirement.
More wide words and good counsel from JM. Thank you.
How helpful. I do advise on and arrange a few PLAs each year, and I think they might see some further interest as IHT mitigation plans, perhaps. Long-term annuity guaranteed periods can be useful, too.
I consider the vast majority of people who will not leave behind an inheritance bill. If IHT is an issue then I am sure that it can be minimised with affordable advice. IHT should not be a pension and a pensioner’s issue