The pension conundrum: buy an annuity or use drawdown?
Falling bond yields have pushed annuity rates to near record lows, but is it right to risk all on the ups and downs of the stock market?
In this example, holding just two years of cash (£7000) would have been the best strategy, but only marginally more so than starting with five years of cash (£17,500). The investor holding two years of cash ends with a pension value of £68,000 as opposed to £52,000 for an individual holding none.
The graph clearly shows that holding as much as ten years of cash protects on the downside initially, but having too much in cash in a recovery will erode value when the market rebounds.
What does the future hold?
We simply don’t know whether global growth will allow stock markets to continue to make steady gains over the next decade. Interest rates and inflation are low, but they may not be so subdued over the next twenty years.
This makes inflation-linked annuities relatively more attractive to own, even if the initial rate is lower, as a 5% plus inflation rate will quickly reduce your purchasing power.
Anyone tempted to go down the drawdown route should remember:
- Changing your mind is okay. You can still buy an annuity after you have retired
- Pound cost averaging can take away some of your initial investment risk, but will not protect you against a large correction further down the line
- Fees really matter in drawdown. Low fees could see your investments last several years longer
- There are no second chances. If you have any doubts, speak to a retirement specialist