Retirement - Annuity or not?

Question

I have a pension worth around £150k and am due to retire soon. With the new pension rules in the UK, what would be some good options to maximise my income post-retirement?

1. Annuity - I will be retiring early, so annuity rates are poor due to my age, I would only get around 4% return per annum, or about £6k income per year. I could continue working for a few more years paying in more to the pot and would then get a better annuity rate as I would be closer to death, but I don't really want to do this!

2. Property - I could withdraw the cash (or a portion of it) and buy property to rent out. I can buy a small house locally for about £40k and that would return around 10% annually, net. However, I would have to pay tax on the lump sum, but I am not sure exactly how the tax is calculated.

Would buying a holiday home abroad be more lucrative? I kind of like the idea of buying somewhere in France or Italy, maybe Spain as I could then holiday there when it isn't being rented out at reduced cost.

Are there any other areas in the UK that would return rental yields much above 10% net?

3. Shares - I could withdraw the money and buy shares for the dividend income, but it is hard to choose shares that yield more than about 6% and they are volatile.

4. Invest in fine wine, art etc - I don't have any specialist knowledge of these kinds of things so it's probably not something I'd want to invest in.

I have other modest forms of income to support myself that will continue even after I retire and no debt, but I would like as high an income from the pension fund as possible. I own my own home so no mortage/rental payments come out of my income/savings.

I am quite fit and healthy so hoping to live for 20 years plus after retiring.

Any ideas welcome thanks.

Answer 1

Firstly, you should familiarise yourself with your options for your pension fund. They changed as of 6th April 2015 so it's all quite new. The Government's guidance on it is here.

If you haven't already taken a tax-free lump sum from your pension fund, you can take up to 25% totally tax free immediately. That makes getting a house for 40K very accessible.

Beyond the 25%, you can take any of it out whenever you want ("flexi-access drawdown" or "lump sum payment", depending on whether you take the 25% out up front or not). That'll be taxed, as if you earned it as income. So if you didn't have any other income, you can take another £10600 without tax this tax year, and then another £10600 or whatever the allowance goes up to next tax year, and so on. Above that you'd have to pay 20% tax until you reach the higher-rate tax threshold at about £40K/year.

You say you do have other income so you'll have to take that into account as well when calculating what tax you'd have to pay. If you've reached state pension age that will add some more income, of course.

Or, as you suggest, you can buy an annuity. You can do that with some or all of the money, and you can still take the 25% tax-free first. If you do buy an annuity the income from it will all be taxed, but again your personal allowance will apply.

Essentially an annuity is the least risky option, particularly if you get one that is uprated with inflation. Uprating with inflation makes the initial income even lower but protects you against cost of living rises as you get older. In exchange for avoiding that risk, you probably lose out on average compared to some more risky options. You might choose to get an annuity large enough to cover your basic needs and take more chances with the rest.

Answer 2

You really should consider sitting down with an independent financial advisor to run the numbers for the various options and discuss what risks you're comfortable with and what your requirements/goals are. This isn't a simple decision, unfortunately.

Advice I've seen suggested that some portion of the money should stay in the market, earning market rate of return. Exactly how much, and invested in what, is complicated.

An annuity is essentially an insurance policy. The company assumes the risks and promises you specific payments in exchange for keeping the money. They wouldn't do so if they didn't think that on average they'll pay out less than the combination of your purchase price plus earnings, so you really are paying a fee for this service. Whether it's worth that cost -- and for how much of your money -- depends on how much you have saved and how risk-tolerant you are.

I'm going to steal a moment here to point out that many charities offer annuities. These may or may not pay out less than commercial annuities, but the profits go to a better cause either way. If you plan to leave part of your estate as donation to a charity anyway, this basically lets them have the money earlier while you continue to receive income from it.

Answer 3

Your relatively young age and the current very low bond interest rates make annuities a very poor buy. And most of the other suggestions you have mentioned have very low diversification, which exposes you to imprudent risks. Buying shares for dividend income can solve the diversification problem by averaging out your totals as different shares change by different amounts. There is no really good solution to the problem of share price volatility except to ignore it: Take your dividends and pretty much ignore the bouncing around of the share price. They usually recover in a year or three. Owning shares of companies that reliably increase their dividend payouts is the only investment type that gives you both diversification and regularly increasing income to counteract inflation over the years. Read some investment books and consider consulting with a financial advisor who charges a fee for the advice. I.e., you don't want "free" advice.

Answer 4

This is not an answer to all of your questions but merely an eleaboration on one of your comments:

Are there any other areas in the UK that would return rental yields much above 10% net? Shares. I could withdraw the money and buy shares for the dividend income, but it is hard to choose shares that yield more than about 6% and they are volatile.

I wrote a post about using shares to invest a pension pot. http://www.sspf.co.uk/blog/016/ You may find it of some interest. Of course, the investing would take place within the pension 'wrapper' so you'd only be paying tax on the income taken out each year.

The other alternatives you mention suggest paying for the expertise and time of an IFA would be a very economical decision. £1,000 to best use £150,000 seems a bargain to me. Some of the avenues you mention seem very risky from my understanding so someone to determine your tolerances and propose a holistic solution is a good path forward.

Best wishes!

Answer 5

Financial advice from good advisers sounds a good idea. Talk to two or three before taking their advice... their services and advice are surprisingly and sometimes alarmingly diverse. Gaining money from renting out property is harder than it seems and 10% sounds very ambitious after all costs. Buying abroad especially is a challenge to make money on.. You need to be lucky, and have a strong flair to do it despite all. Bear in mind santander pay 3% on current accounts by the way. Have you ever thought about living abroad somewhere stable or cheap or downsizing. A part time job or low pressure job might top up a limited pension for long enough to find a long term solution while giving you the feeling of starting retirement. Just some thoughts... think it through carefully .. weigh the risks.. be realistic and good luck. Jonjo

Answer 6

Be very careful about terminology when talking about annuities. You used the phrase "4% return" in your question. What exactly do you mean by that? An annuity that pays out 4% of its principle is not giving you a "4% return" in the sense of ROI, because most of that was your money to begin with. But to achieve a true 4% return in the current environment where interest rates are at historic lows on anything safe (10 year UK Gilts at 0.91%) would make me very nervous about what the insurance company is investing my annuity in.