Why pension drawdown is up 200% since the pension freedoms

In the second quarter of 2013, two years before the pension freedoms, the Financial Conduct Authority counted 78,390 annuity sales¹. Only 14,403 drawdown contracts were sold in this same period, largely because of rules stating that income drawdown was only available to those with over a certain amount of cash in their pension pot.

By the second quarter of 2015, the picture had changed drastically. Just three months after the introduction of the pension freedoms in April 2015, annuity sales had plummeted to 13,738 and drawdown sales had jumped to 33,886.

Now new figures for the second quarter of 2017 reveal another hike in drawdown contract sales to 42,776, up by almost 200% from the days before the pension freedoms.

Explaining decline of the annuity…

Some of this is because drawdown is simply more available than it was before. However, given the consistently poor annuity rates seen over the past few years, it’s not surprising that retirees are turning away from such arrangements.

Thanks to a new Annuity Rates Calculator from wealth management firm Drewberry, the public can now calculate the annuity they might receive from their pension pot.

£100,000 in retirement savings will buy an index-linked annuity of only around £3,323 per year for a healthy 65-year-old. This assumes she:

  • Is non-smoker
  • Has bought a single annuity without a guarantee period
  • Has taken her 25% tax-free cash upfront
  • Lives in the same postcode as Drewberry’s team of Brighton-based financial advisers.

Clearly, with an annuity you don’t get very much for your money.

…and the rise of income drawdown

Plugging the same figures into Drewberry’s Pension Drawdown Calculator reveals how much more drawdown might afford you in retirement. Chiefly, this is because you pot stays invested, providing room for growth even after you retire.

Yet the disparity between drawdown and annuities is also a reflection of current annuity rates. These have been pushed to record lows by rock bottom interest rates and dismal yields on government gilts.

Taking the equivalent of an index-linked annuity from a drawdown pension pot would see the fund last until the age of 95 if it only grew by 2% each year in retirement. This is above a woman’s life expectancy at 65 (currently 89). At the age of 89, a woman whose £100,000 income drawdown pot had grown by 2% each year in retirement would still have £33,162 remaining to leave to any heirs if she died.

If she wanted her pension pot to last exactly until the age of 89, she could take an income around 25% higher from her drawdown pension than she’d receive from an indexed annuity.

If her drawdown pot grew by 4% each year, then her pension would stretch out to the age of 111 if replicating an indexed annuity. What’s more, if this is all she took from her pension then the power of compound interest means her pension pot would hardly be dented by the age of 89. She’d still have almost £100,000 invested.

Longevity risk

Of course, with pension drawdown you’re still running the risk that your pot will run out. No matter how low rates are currently, this isn’t something you have to worry about with an annuity.

If you take too much, too soon from drawdown, or simply live longer than you were expecting, as is increasingly common, you may find yourself without a pension to live on. At 89, the average woman is still expected to live for another five years. This could be in increasingly poor health, perhaps with a need to pay for long-term care, which could quickly drain any remaining pension pot if it hasn’t already been exhausted.

Longevity is the chief risk with pension drawdown. However, appropriate advice and proper financial planning can minimise this risk. This could see you benefit from the greater flexibility offered by pension drawdown while also potentially providing a higher income than you’d ever get from an annuity.

When the figures stack up like this, the 200% explosion in drawdown contracts starts to make a lot of sense.

¹ – https://www.fca.org.uk/firms/product-sales-data/interpreting-data