Explain it to me like I’m 5…

[Harperlea]

What on earth is Critical Yield when you’re taking pensions? Why do I need to know it?

My understanding…

Let’s say you have a pension that is scheduled to be used to buy you an annuity that pays you £4,000 a year rising with inflation of 2% each year - let’s say this costs you £100k

Let’s say you didn’t want to buy an annuity - you wanted to exercise more flexibility and choose drawdown, albeit drawdown at a rate matching the annuity payments.

Critical Yield is a calculation of the growth rate that your £100k pot would need to grow each year to guarantee matching the annuity’s £4,000 + inflation per year.

In theory this could be 4% + whatever inflation happens to be or less - it depends how long you live. So if inflation is 2% per year you would maybe need at least 4% + 2% = 6% growth each year to match the annuity.

Most people choose drawdown not to match an annuity but to get access to the 25% lump sum.