If you’re approaching retirement and can’t decide whether you want the flexibility of income drawdown or the security of annuities, combining the two could provide the answer.

This blended approach gives you the opportunity to keep growing your money while still receiving a guaranteed income for life.

WHAT’S THE DIFFERENCE BETWEEN AN ANNUITY AND DRAWDOWN?

Annuities and income drawdown sit at opposite ends of the investment risk scale.

An annuity provides a guaranteed income for life. How much income you get depends on factors like your health and lifestyle, how big your pension pot is, annuity rates at the time you buy the policy, and where you expect to live when you retire.

An annuity could be suited to someone who qualifies for an enhanced annuity because of ill-health, who has little or no appetite for investment risk, or whose income needs are unlikely to change significantly during their retirement.

Once you buy an annuity, you can’t change your mind.

With income drawdown, your pension money remains invested. You can decide which investments your money is put into and how much income you want to take.

Drawdown income is not secure. Your money could run out if you withdraw too much, you live longer than expected or your investments don’t perform as you hoped.

Drawdown can be appealing to investors who have other sources of income or want to flex their income to meet their individual needs.

WHY SHOULD I THINK ABOUT COMBINING THE TWO?

Combining the two approaches enables you to benefit from a guaranteed lifetime income in addition to investment growth.

Fiona Tait, technical director at Intelligent Pensions, says many investors want to achieve both flexibility and security, particularly if they are facing the possibility of 20 to 30 years in retirement.

‘This allows the individual to cover some or all of their fixed expenses, with the flexibility to adjust their withdrawals for discretionary expenses and also to potentially offset some of their income withdrawals with investment growth,’ she explains.

It’s worth remembering that if you use drawdown you can buy an annuity at any time in the future with all or part of your fund. Annuity rates typically become more attractive in older age.

HOW DO I COMBINE THEM?

The two main routes to combining annuities and drawdown are do it yourself or opt for a ‘hybrid’ product.

The DIY approach involves using a portion of your pension pot to buy an annuity and putting your remaining funds in a drawdown account.

Tom Selby, senior analyst at AJ Bell, says you shouldn’t use a single provider for both products because you might be able to get a better drawdown deal elsewhere.

The advantage of doing it yourself is the invested portion will be tailored to your own circumstances.

HYBRID PRODUCTS

A hybrid product enables you to combine annuities and drawdown in a single wrapper. Hybrid solutions are offered by companies such as Retirement Advantage and LV=.

Andrew Tully, pensions technical director at Retirement Advantage, says annuity income can be reinvested within the drawdown wrapper, which can create significant tax planning advantages.

You can choose to de-risk your drawdown portfolio by gradually buying annuities over time, any of which can have different guarantees and death benefits.

Annuity income can be stopped and started at any point in a combination plan, unlike traditional annuities where it is fixed.

Fiona Tait of Intelligent Pensions says hybrid products are advantageous in that you only have one plan and one income payment to keep track of. In addition, the annuity portion often offers more flexible benefits than a conventional annuity, particularly around death benefits.

‘These advantages do however typically come with either an increased cost or some kind of restriction such as reduced investment choice,’ she adds.

COULD ANNUITY RATES IMPROVE?

One of the reasons why annuities have become increasingly unpopular in recent years is the rapid decline in the annual payouts on offer from insurance companies.

This has been driven by a steady drop in yields on long-term gilts issued by the UK Government, partly as a result of the post-financial crisis Quantitative Easing (QE) programme.

Insurers buy gilts in order to pay incomes to annuity customers, so when the yield drops the rates offered also drop.

AJ Bell’s Tom Selby says if interest rates and gilt yields start
to pick up from their current levels then annuity rates should follow suit.

This, in turn, would mean a smaller proportion of your pension would be needed to secure your minimum income requirements and more of it could be invested for growth.

There is, of course, no guarantee interest rates will rise this year.

Blended plans are only available to buy through a regulated financial adviser. Tait suggests seeking financial advice regardless of the solution you choose.

‘A financial adviser can help you to create an income plan and calculate how much of your fund should be used to secure guaranteed income and to plan withdrawals from the remainder so that they are unlikely to run out too soon,’ she says.

‘The financial adviser will also be able to recommend a reasonably charged product and source the most favourable annuity rate for your age and state of health.’ (EP)

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