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Pension freedoms four-year anniversary: are savers withdrawing sensibly or splurging irresponsibly?

AJ Bell has recently set out in a press release results of research it has undertaken indicating that, on average regular annual withdrawals from a drawdown pension arrangement, under the pension freedoms are 4.7% of fund value, almost a third lower than 12 months ago. Also, savers appear to be reacting to market volatility and Brexit uncertainty, with expected investment returns down from 4.83% to 4.15%. 1 in 10 pension drawdown investors have experience a significant drop in fund value since entering drawdown with around half cutting withdrawals as a result.

Please not that these are withdrawal returns associated with a Drawdown pension scenario, not via the purchase of an annuity. Many of today's retirees have the opportunity to live the kind of life they want to after decades spent juggling family and career demands. They also have much more freedom to use their pension savings how they like. Depending on the choices they make, they can keep their options open through retirement and manage their pension pot to meet specific goals that may change over time.

Yet, for many, the most valuable freedom will continue to be the ability to enjoy a reasonable standard of living in retirement without the risk of running out of money. The surest way of doing that is to convert pension savings into an annuity.

Annuities provide security, stability and a range of other benefits. They used to be the default option for those reaching retirement. Yet they have become much less popular in the UK since the introduction of pension freedoms. In its first figures released this year, the Financial Conduct Authority says between 10% - 15% of retirees are now selecting annuities, while 30% are opting for drawdown and 55% are taking full cash withdrawals.

Annuities work by providing you with a guaranteed amount of income per month based on a number of different factors, the most important being interest rates and life expectancy. However, the downsides of investing into an annuity are:

  • Value for money Although annuity rates have been improving recently, they are still low by historical standards.

  • Lack of control Many people prefer to be more involved in deciding where their pension savings are invested.

  • Inflexibility Even though annuity products may come in many shapes and sizes, income is generally inflexible and does not allow for changing needs and circumstances.

  • Inheritance While an annuity will give you certainty, the income dies when you do, leaving nothing for your heirs.

  • Underestimates of longevity The Institute of Fiscal Studies has found widespread “survival pessimism” at all ages. This may make individuals reluctant to buy annuities, as they think that they will live shorter lives than they are statistically likely to. As a result, some retirees may ask: “Will I live long enough for this to pay off?”

What this demonstrates is the need for people to consider all options at retirement, and the importance of including annuities in these. For decisions as complex as accessing pension savings, individuals should seek advice. Without it, many may be taking out plans without fully understanding the risks.

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