I’m 34, make regular contributions into a defined contribution company pension, and until recently have pretty much ignored it.
I logged on to have a look at the provider’s new portal and noticed I had a new range of options which boil down to me choosing now if I think I’ll be wanting to take an annuity or a drawdown pension.
What it doesn’t tell me is how this choice affects what I might get when I hit the magic age. Which is the least ‘risky’? If I say drawdown, but later decide annuity, does that put me in a worse position than if I flipped it around?
Retirement decision: How do I choose between pension drawdown and an annuity? (Stock image)
Should I be trying to split the pots – I’ve got a couple transferred in from other places? What if drawdown doesn’t exist in the future? What if some magical new pension option appears?!
I’m not looking for the differences between the options at retirement, more about the investments which will be made now. Help?
SCROLL DOWN TO FIND OUT HOW TO ASK YOUR PENSION QUESTION
Steve Webb replies: The choice that you now have arises from the ‘pension freedoms’ which were introduced in April 2015.
Until that point, the large majority of people who built up a pot of money in a pension used it at retirement to buy an income for life or an ‘annuity’.
Steve Webb: Find out how to ask the former Pensions Minister a question about your retirement savings in the box below
After the introduction of pension freedoms, savers no longer have to use their pension pot to buy an annuity.
Now, they have the option to take all of it out in one go (though potentially facing a big tax bill if they do so) and spend it how they want, they can leave the money to go on being invested and draw down on it when they wish through retirement, or they can still buy an annuity.
How might this affect your investments?
In the past, your pension company was safe to assume that most people would buy an annuity at pension age.
As you got older they would gradually switch your investments out of assets such as shares which were more risky but would generally generate a bigger return and into things like government bonds which will give a lower return but are less volatile.
This process was known as ‘lifestyling’, and it typically started 10 years before someone’s retirement age.
The idea was that people who are about to buy an income for life with their pension pot don’t want to find that the value of their pot has changed dramatically in the months and years just before they retire.
By switching the investment in your pension in this way, the intention is to make it more predictable, especially as you get nearer to retirement.
Since pension freedoms, most people no longer buy an annuity when they reach pension age and this gives the pension companies a dilemma.
What is a defined contribution pension?
Most private sector employers now offer defined contribution pensions.
These take contributions from both employer and employee and invest them to provide a pot of money at retirement, but the worker bears all the investment risk.
They are stingier and riskier than traditional defined benefit – or final salary – pensions which provide a guaranteed income after retirement until you die. This is Money
If most people will go on investing their pot *after* retirement, in order to go on benefiting from the growth in those investments, then it seems rather odd if the pension company has switched you out of shares just before you retired.
In response to this, many pension companies have now changed the assumption that they make about people’s future plans. Most have now switched to assuming that you will not buy an annuity but that instead you will go into drawdown.
The practical consequence of this is that your pension will now stay invested in higher return but higher risk assets for longer.
However, very few investments are absolutely certain and even government bonds can go up and down in value.
How do you decide what to tell your pension provider?
As you have found out, although the company makes one assumption for the scheme membership as a whole, you have the right to make a different choice.
If you know that you intend to buy an annuity (or that is your most likely choice) then you can indicate this to the scheme and they will switch you out of higher return/higher risk assets much sooner.
If you are really not sure, you could, as you suggest, ‘mix and match’ with some of your pensions adopting one approach and some the other.
For someone of your age, both options will probably look pretty similar for the next 10-15 years. It is only really once people reach the age of 50 that lifestyling would start to have a significant impact in most schemes.
How do government bond markets work?
We cut through the jargon and explain how they affect YOUR savings, pension and investments. Read more here.
Could pension drawdown be abolished?
You ask what would happen if drawdown were no longer available in future. Whilst it is possible that a future government could make such a change, pension freedoms have been so popular it seems unlikely that the ability to shape your retirement income to fit your needs would be abolished altogether.
In the extreme case that drawdown was abolished and everyone was forced to buy an annuity then you would probably have a few years’ notice (as the necessary legislation was enacted).
This would enable your pension provider to start to move you to lower risk assets that would be a more natural lead-in to buying an annuity with your pension pot.
ASK STEVE WEBB A PENSION QUESTION
Former Pensions Minister Steve Webb is This Is Money’s Agony Uncle.
He is ready to answer your questions, whether you are still saving, in the process of stopping work, or juggling your finances in retirement.
Since leaving the Department of Work and Pensions after the May 2015 election, Steve has joined pension firm Royal London as director of policy.
If you would like to ask Steve a question about pensions, please email him at firstname.lastname@example.org.
Steve will do his best to reply to your message in a forthcoming column, but he won’t be able to answer everyone or correspond privately with readers. Nothing in his replies constitutes regulated financial advice. Published questions are sometimes edited for brevity or other reasons.
Please include a daytime contact number with your message – this will be kept confidential and not used for marketing purposes.
If Steve is unable to answer your question, you can also contact The Pensions Advisory Service, a Government-backed organisation which gives free help to the public. TPAS can be found here and its number is 0800 011 3797.
Steve receives many questions about state pension forecasts and COPE – the Contracted Out Pension Equivalent. If you are writing to Steve on this topic, he responds to a typical reader question here. It includes links to Steve’s several earlier columns about state pension forecasts and contracting out, which might be helpful.
If you have a question about state pension top-ups, Steve has written a guide which you can find here.