Or have I completely misunderstood how pensions work

[supersuds]

Just reading my annual pension statement. Appreciate I am lucky to have one.

It gives a figure which I could expect to have annually if I keep saving and retire at 60 as an annuity. When I look at how this is calculated it's based on a statutory definition from the financial reporting counsel.

The problem is the amount it says I could have in an annuity, is less than the actual amount ie if I divide the amount it says I could have as an annual annuity by my projected total savings, just drawing down the amount from the total savings, would last until I was well over 100

Ie if I have a projected pot of 250k, it says I can have an annuity if 5k a year. Even if I took the 25k tax free it would last until I was 105 if I just drew down the same amount annually from the pot.

Are these calculations/ annuities a crock of shit? Or have I misunderstood.

OP, I'm no expert but I suspect the distinction is: assuming no drawdown of the capital, that's the teeny tiny income you'd get from the intact and untouched pension pot. So a product that gave a combination of income and drawdown would give a bigger cash flow.

Hopefully someone more knowledgeable will be along soon, but am I right in thinking annuities are a really bad deal these days?

There's a good explanation here but I'd say £5I is probably half what you should expect.

The assumptions used by the providers aren’t necessarily reflective of how you would actually approach drawing your own retirement income. They assume that you purchase an annuity from the fund (i.e. a guaranteed inflation for life), which fewer people tend to do these days. Many people now opt for Flexible Income Drawdown which allows you to draw flexibly from the fund as needed with no cap on income, and which also allows you to pass on any residual pension fund on death.

Annuities work well for some but with gilt yields as they are, the rates are generally unexciting, particularly if you write in additional options like spouse’s pensions, guarantee periods and/or inflation linking.

Another factor is that providers have to use a pretty pessimistic mid rate of return for illustrations now which also reflect inflation. This is yet another reason why people are finding that their pension illustrations now look significantly less rosy than they may have done a few years ago.

Gilt yields are stupidly low at the moment so the cost of guaranteeing an annuity is very high for providers, hence the low rates illustrated. Inflationary increase will also be factored in which drawdown won't protect against.

I switched from a work place pension with defined benefits...the experts say that you should never do it, but I was due to get £7500 a year...with the amount the pot was worth I could have got an annuity of at least 12000! So if I draw down 12k a year and given the improvement to the value by having it better managed, I will have enough to last until 104 years old!

Inflation.

The annual annuity will be Inflation linked.

An annuity is not likely to be a good choice.

For myself, I have my main pension invested in various growth funds. I am not drawing it yet.

If I divide its current value by the number of years I plan to live, I could take out partial encashments and it would last longer than me. Even if it stopped growing tomorrow and never started again, which is unlikely.

I am aware that it can fall in value. I think it was 2007/8 it lost over a third. But has since more than doubled.

Those talking about drawdown and pension lasting till 104 are perhaps forgetting inflation. If you're drawing down £10,000 a year, and inflation stays as low as 2%, then to have the same purchasing power after 20 years of retirement, you'd need to be drawing down almost £15,000.

with the amount the pot was worth I could have got an annuity of at least 12000

Hopefully that was inflation-linked, otherwise it's not a fair comparison.

Annuities are not really recommended any more. Not sure the PP has understood their inflation linked DB pension very well.

My understanding is the pension statements have to show you an annuity. Low interest rates mean no one would take one.
My plan is to have 10 years of fun money saved by the time I am 65. That will do me.

@Userg1234

I switched from a work place pension with defined benefits...the experts say that you should never do it, but I was due to get £7500 a year...with the amount the pot was worth I could have got an annuity of at least 12000! So if I draw down 12k a year and given the improvement to the value by having it better managed, I will have enough to last until 104 years old!

Oh jeez. You should have listened to the experts. 🙈🙈

I did listen...the draw down is based on today's figures. The pension pot, like all of them is invested and is continuing to grow, growth currently exceeds £12k per year. I will be in receipt of a full state pension at 67. I also have other savings. I am just making the point that you need explore every option. And the traditional approach of annuities is not a positive one at present

@Userg1234

I did listen...the draw down is based on today's figures. The pension pot, like all of them is invested and is continuing to grow, growth currently exceeds £12k per year. I will be in receipt of a full state pension at 67. I also have other savings. I am just making the point that you need explore every option. And the traditional approach of annuities is not a positive one at present

If you had a DB pension annuity values would have been irrelevant to you. You just gave up such a valuable guaranteed income. Why do you think pension schemes are moving from DB to DC and members fight against it? It's not because it gives a better pension for the employee now is it?! It is highly highly unlikely that you will be better off in the long run giving up a DB pension for drawdown.

I would advise people to ring the governments free national pension helpline. It will tell you exactly how was many years contributions you have towards state pension and your expected retirement age.

Defined benefits pension schemes are always the best. People just see a figure and forget about inflation, performance rises and fall. Don’t ever change a defined benefits scheme if you don’t have to.

An annuity is an insurance product - like life insurance in reverse. Instead of promising to pay something when you die, it's a promise to pay an income for as long as you live. For this reason they will always be poor value in comparison with the alternative - to draw down from the fund. You are paying a premium for the guarantee that come what may, that income will be paid. The Insurer is taking a calculated risk based on their stats about how long people will live.
You will always pay a price for reducing risk.

@DynamoKev - you are right about the insurance / risk element, but for that reason it doesn't mean they are poor value. If you want the peace of mind that your income won't run out if you live a long time and don't want to take investment risk then an annuity provides that certainty.

I agree that the rates are not very attractive but that's because these days people can be expected to live decades after retiring and insurance companies have to invest in long-term assets with limited risk in order to fund the guaranteed income. Since the credit crunch interest rates have been extremely low making the investment very costly for the insurer, and that's reflected in the rates they offer.

[quote DadDadDad]@DynamoKev - you are right about the insurance / risk element, but for that reason it doesn't mean they are poor value. If you want the peace of mind that your income won't run out if you live a long time and don't want to take investment risk then an annuity provides that certainty.

I agree that the rates are not very attractive but that's because these days people can be expected to live decades after retiring and insurance companies have to invest in long-term assets with limited risk in order to fund the guaranteed income. Since the credit crunch interest rates have been extremely low making the investment very costly for the insurer, and that's reflected in the rates they offer.[/quote]
Agreed

Problem with annuities is you need to live for at least 20 years just to get the capital back, but you are guaranteed the amount for the rest of your life. If you die 5 years in, the insurance company get the remainder of your pot. So good if you live a long time, bad if you don't. Drawdown is the opposite. You may be able to take a higher amount, but once the pot is spent, that is it. But, if you die whilst there is still money in the pot, it goes to your estate, not the insurance company. Drawdown suits me.

Hi, @supersuds, I'm an actuary working in life insurance - I even used to program these type of calculations for my company, although that was a while ago!

The key factor here is inflation. The illustrated pension is in today's money terms, and is assumed to increase with inflation until you die. So this is an annuity that will protect you against price rises in the future. As you might be aware, interest rates are very low at the moment, so it is very costly for an insurance company to buy assets that will fund an index-linked guarantee.

Bear in mind that someone retiring at 60 could easily live to 90, and insurers are providing insurance to protect against life expectancy continuing to increase, and it is understandable why the rates being offered for annuities are so low. (Although I'm not expecting lots of sympathy for insurance companies here).

The government has given us a choice with our pension pots when we retire:

We can keep them invested in the stockmarket (or other assets), draw the income we need and take the risk ourselves of living a long time (and the pot running out), inflation spiking (so the pot doesn't keep up with the cost of living) and investment risk (market crashes etc).

Or take an annuity - we can transfer all that risk to an insurer through a guaranteed income, which we can index-link if we wish. Naturally, there is a premium to be paid for that guarantee.

Honestly I don’t understand how pensions work. Unless you live for a ridiculously long time you end up getting less out than you put in!

When I read the OP I thought, she needs a life insurance actuary to explain this to her. Lo and behold, MN delivered the goods!

Some really good explanations here, I've never really understood pensions. I have an NHS one, on their new terms so apparently not as good as the old style but as I don't understand them I don't know what I'm missing!

But now I know what an annuity is, so thanks everyone!

@Iamthewombat

When I read the OP I thought, she needs a life insurance actuary to explain this to her. Lo and behold, MN delivered the goods!

@Amima

Honestly I don’t understand how pensions work. Unless you live for a ridiculously long time you end up getting less out than you put in!

I wonder what you think is a ridiculously long time? According to ONS data for recent mortality rates (pre-pandemic), if you take a representative sample of 60-year old women in the UK, more than one-third of them will live to the age of 90 !

Because life expectancy is likely to increase in the future, and people well-off enough to have pension pots and choosing to take an annuity are likely to live longer than the UK average, an annuity has to insure against a chance somewhat higher than 1/3 that you will live for a 30 years or more (if you are 60).