The benefits of a pension annuity
Here we consider the benefits of pension annuities and why income drawdown should be approached with caution. There really is no argument to suggest that income drawdown will eventually replace pension annuities, although there is a role for income drawdown and variable annuities for the right customer at the right time.
Let’s consider annuitisation. It can work within pension annuities invested in unitised funds thereby enabling a higher lifetime income in exchange for giving up capital on death. There is therefore no suggestion that income drawdown will replace pension annuities simply because drawdown can invest in equities and enjoy the benefit of the equity risk premium.
The critical difference between annuities and drawdown is the impact that annuitisation has on the trade-off between income and death benefits. Higher death benefits result in lower income and vice versa - you can’t magic something out of nothing or magic the risk away.
One major reason why drawdown will not replace annuities is the size of pension funds. Too many are too small; over 75% of current funds are less than £30,000 after the 25% tax free cash has been taken.
Hopefully, fund sizes will increase significantly in the future and this may lead to higher drawdown take up. But there are always going to be a lot of pensioners with insufficient funds to be able to afford the drawdown route, and who will get better value from buying a new generation pension annuity product.
