Retirement

If you are delaying buying a retirement income for a year in the hope that annuity rates will improve, think again. It can take 36 years to recoup 12 months' lost income. Historically low annuity rates have brought confusion to many people in terms of what to do – buy an annuity now or defer to a later date.  

Make the most of your retirement lump sum

In the absence of a crystal ball it is impossible to second guess what is the right thing to do. This article suggests a logical way of approaching the decision and assumes that you are not attracted to idea of income drawdown – probably regarding it as too risky.

Firstly, think about your income needs over the next year or two. You may be in a position to defer annuity purchase because you are in some sort of paid employment or because you have other investment income.

Secondly take an empirical approach to the cost of deferral. The following is a suggested approach:

1. Obtain an annuity quote for your current age. Go to www.annuitydirect.co.uk where there is a real time quotation facility.
2. Obtain a quote for someone who is older by the number of years you wish to defer. 
3. Calculate the total income you will receive over the deferral period.
4. Calculate the extra income you receive by deferring (this assumes rates are available at current levels). 
5. Divide the total income (step 3) by the extra income (step 4). This gives you the number of years you need to live and draw the additional deferred income in order to recoup the total income you can receive in the deferral period by buying an annuity now.

The following example amplifies this:

1. A male born in March 1950 with a £100,000 fund can obtain annuity of £6148 by buying the annuity immediately.
2.  If he defers to age 65 the income, at current rates, will be £6792p.a.
3. If he buys the annuity now he will draw it for 52 months and the total income over the deferral period is therefore £26,795.
4. By waiting he receives an extra £644 p.a. Divide this by £26,795 and he needs to live for 41.6 years to break even – ignoring interest.

If annuity rates rise then the term to break even will be shorter. However bear in mind that solvency 2 is around the corner with pundits estimating a reduction of 10% - 20% in rates as a result of this.

The one other consideration is the fund investment strategy. Traditional wisdom says that the closer you are to retirement the less risk you can take with the fund. This means that a strategy needs to be adopted whereby funds are invested in low risk – and therefore low yield funds which does not assist the calculation. Of course, if you can afford - and are willing – to take more risk then the calculation above can vary wildly.

The key message has to be – take care and examine the options and the maths critically.

Bob Bullivant