It is most definitely worth working out what your potential pension pot could actually buy for you in terms of income and a tax free cash lump sum for your retirement and we believe that annuity rates can provide a very decent ‘bottom line’ indicator.
There is no doubt that the importance of pension contributions has been boosted by the rollout of Auto-Enrolment pension schemes, or Workplace Pensions as you might know them. However what is not as clear is what your savings will actually buy for you when you come to retire.
Take for example Louise, who is a healthy, non-smoking 65-year-old and – lucky her – she reaches retirement with £1,000,000 in her pension plan (she must have had a good IFA along the way!).
If Louise uses her entire pension fund to buy herself an inflation-proofed income, what will be her first monthly pension payment before tax is deducted?
The answer is A, based on current pension annuity rates.
After tax, if Louise has no other income, her monthly payment will be about £2,200. If she were to incorporate a 2/3rds widow’s pension the gross amount drops by about £400 a month.
Given the sheer size of Louise’s pension fund, this level of pension income may be a surprise to you, especially given that the National Living Wage is nearly £1,200 a month for a 35-hour week. Moreover, in additional context, you have to take into account that she has chosen to relinquish a tax-free lump sum of up to £250,000 in favour of a higher pension income!
Whilst the pension of £2,500 a month is only 3% of Louise’s pension pot, it is RPI-linked and, importantly, because it is an annuity payment it is also guaranteed throughout her life – however long that may be.
You can however see that whilst annuities have gone out of fashion with the advent of ‘Pension Freedoms’ and ‘Flexi-Access Drawdown’, the rates can set a base line for retirement planning.
Alternative retirement incomes, such as Drawdown, do carry some form of investment risk and the potentially higher incomes which are available do not have the same degree of security as the annuity route…even though they do offer many other possible personal advantages.
The increases in Workplace Pension contributions from April are a necessary beginning on the way to building up adequate retirement funds, but a realistic level of pension contributions will need be much higher for most people who want a financially comfortable retirement.
Please Note: The value of your investment can go down as well as up and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance. The value of tax reliefs depends on your individual circumstances. Tax laws can change. The Financial Conduct Authority does not regulate tax advice.