Thursday, 27 March 2014

A new beginning

We have launched a new website which replaces this blog -

The sole purpose of “Shining Lights” is to provide varied sources of quality information and analysis on the subjects of managing finances and investing money.

It is inspired by a simple idea but an idea which can create profound change.

“Being the difference you wish to see.”

It has not been created to sell a product and it's not going to promote a service. Indeed we can assure you it's not for profit.

Thank you for your support and please like us on Facebook or follow us on twitter. 

Tuesday, 25 March 2014

Annuities vs drawdown vs cash

In my second blog on the budget announcement I want to explore further the idea of annuities being dead…..

The table below compares drawdown income to an annuity:

Drawdown Income
Annuity Income
Pension Fund
Tax free cash
Total income

Note: based on a male age 65, single life annuity with no increase, no guarantee and no spouses pension. Tax free cash is assumed to be held on deposit at a rate of 3% p.a.

The alternative option is to take the whole fund as cash. After tax this would be around £81,000, assuming this was held on deposit at a rate of 3% this would give an income of £2,430 p.a.


Journalists have welcomed the idea that pensioners have the flexibility to take their entire pension fund as cash. However to achieve an equivalent drawdown income they would need to generate returns of just over 9% a year to deliver the same income. Annuity income is slightly less at 6.5%.

Taking the cash creates a number of challenges, firstly how to achieve a return of 9%. There are potentially two options – property or equities. A recent survey indicated that an individual could buy a property in Blackpool for £75,943 and achieve a monthly income of £494. However, ignoring tax there will be letting agent fees, insurance, maintenance costs and periods when the property is empty which means the actual income is less.

Assuming around £100 is set aside to cover costs this means the yearly income is £4,728 p.a.

An alternative is investing, the Telegraph recently suggested that 10% should be placed in short term government bonds and 90% in the FTSE 100. Assuming a 5% return on the FTSE 100 over the past ten years, and 1.77% on Government Bonds this will deliver a yearly income of approximately £3,600 p.a.

Other potential challenges include inheritance tax planning, flexibility around income and life expectancy.

With the tax upfront and limited investment options cash seems a high risk option for a cautious investor, but may appeal to the more speculative investor or those with other sources of income.

Drawdown vs annuity

Drawdown provides people retiring with greater flexibility because of the level of income they can take, the ability for the pension fund to be passed down to their spouse and for it to remain outside of their estate for inheritance tax planning.

However, there is a risk. Assuming the maximum income of £6,637 is taken then the return needed is just under 9%. This means that the individual will need to carefully manage their money to ensure that the fund doesn’t run out. Assuming no growth the fund would disappear within 11 years. With an average life expectancy of 20 years, this means nine years of no income.

In reality most people don’t take the maximum income for this reason.

With an annuity the individual will know what they will get each year until they die, this is guaranteed whatever happens. However, to add increases each year, spouse’s pension and a guarantee means the income will reduce. The provider of the annuity takes on the risk. Roughly on £75,000, they are assuming a life expectancy of 16.5 years. If an individual lives less than 16.5 years then the provider wins, if they live longer then they win.

Flexibility or complexity?

Journalists assumed that the budget meant an end to annuities however the examples show that although there is flexibility individuals may still prefer the security of annuities to drawdown (or cash) especially where this is the only source of income.

There is greater flexibility now but it is no more complex than it was before. What these changes do is provide individuals with greater choice and as with all financial planning the right choice will depend on the individual’s needs. The idea of having all the cash up front is appealing but when it needs to be managed for an unknown period this perhaps brings too much risk for many.

Monday, 24 March 2014

Are annuities dead?

According to most financial papers, the answer is yes……

This means that companies like Just Retirement and Partnership Assurance are dead because this is the majority of their business.

But perhaps the journalists and markets are overreacting.

More choice

The retirement market needed a radical overhaul.

Within the last twenty years guaranteed pension schemes have declined significantly, with only 13% of final-salary schemes open to new joiners and very few FTSE 100 companies offering schemes to new members.

This means a new generation of savers have to adapt to an uncertain retirement in terms of income also life expectancy.

Mixed in with increased life expectancy, lower gilt yields mean annuities have reduced significantly over the past decade.

Pension drawdown was introduced to provide flexibility in retirement. However, the fear was that individuals would use all the money to “rinse” their fund. Therefore protection was put in place.

In the last five years these factors have come to a head, and until now no government has been bold enough to tackle this head on.

Are annuities dead?

The assumption is that individuals will be happy to take control of the management of their pension fund in retirement. There are a number of elements to this, firstly how much income is needed, how the remaining fund is invested and how long it is expected to last.

When the dust has settled the outcome will be that some individuals will be happy to do this, some will outsource to financial planners and some will opt for annuities.

What we may see are new product ranges but effectively there will be no change other than individuals will have more choice and flexibility.

Is this good news

Yes, individuals have been asking for some time to have more choice in retirement and these changes respond to this.

However, there are some obvious dangers.

  1. If an individual takes the entire pension fund out, then it will be taxed as income. This means a pension fund of £100,000 will actually be worth around £81,000 after tax
  2. Individuals going into retirement homes could find that their pension is assessed as eligible to pay the fees. Where before there was a restriction on the income from the pension, there is now no restriction. This means potentially the pension could reduce a lot quicker leaving nothing for the spouse or dependents
  3.  Security – annuities provide security, assuming life expectancy is twenty plus years then individuals opting for annuities know they will get a guaranteed income until they die. For some this will remain an attractive option. If individuals believe this is wrong then drawdown or taking all their pension fund as cash opens up a greater degree of risk because the responsibility for ensuring the income lasts rests with the individuals
  4. Financial education – there is an assumption that financial education is strong, however a number of reports indicate that this is not the case and that our schools are failing our children. If the financial education is not there then this opens up potential dangers where money is wasted and squandered

Where now

This is great news but needs to be handled carefully. One of the greatest fears about drawdown was that individuals would “rinse” their pension fund and then the state would have to provide for them, protection was put in place to stop that. That protection has now gone but those fears remain.

Individuals reaching retirement now have access to “free” advice and will need to make a choice. Annuities although appearing to offer poor value for money do offer security whereas drawdown requires careful management to ensure the same level of security; ultimately this will depend on the individual.

The markets (and analysts) have priced in armageddon for Just Retirement and Partnership Assurance on the assumption that annuities will never be written again. They could be right but in reality one of greatest fears in retirement is uncertainty and hence the use of cash, will individuals want to give up the security of annuities?