£100,000 pension pot? How to avoid being penniless at 80
How long will your pension savings last in retirement? Analysis by investment advisers Hargreaves Lansdown suggests that drawing down much more than 5% a year could leave you penniless in your 80s.
Hargreaves examined the real-life outcome of retiring in 2000 with a pension pot of £100,000. It found that if you took out 7% a year – in other words you drew down £7,000 annually – by 2014 your money would have run out.
If you took 6% a year there would still be a little left, but you would be on track to have nothing by 2020. But if you drew down 5% a year you would still have around half your pot of money left.
The figures are important for the millions of people facing the tough decision about how to string out their limited savings for a retirement that, on average, should last 18.5 years for a male taking his pension at 65, and 20.5 years for a woman.
Employees in final salary schemes – mostly in the public sector – are relatively safe as they know their former employer will carry on paying them an income throughout their retirement. But most private sector workers are now in defined contribution schemes where they build up a pot of money and hope for the best.
Hargreaves says that in many ways the best option for someone in 2000 would have been to accept a lower income at first, but invest the money in equity income funds. These produce an income that, if all goes well, increases over time. The firm says that someone taking this option in January 2000 would have received an income of just £2,052 in the first year, growing to £4,146 last year. Just as importantly, the money would not have any risk of running out – indeed, their pot would have grown, standing at £124,803 compared to the £100,000 at the start.
The much-maligned annuity was not a bad option either, especially back in January 2000. If a male retiree put £100,000 into a single life level annuity at the start of the millennium, he would have picked up a generous income of £9,230 a year, and still be receiving that today. That means the annuity would have paid out £156,910 so far.
But if that man had died shortly after retirement the money would have entirely reverted to the insurance company. Equally, if he lived well into his 90s the annuity will have paid out handsomely. Unfortunately, today’s annuity rates are far below the 9% available in 2000, with the best-buy deal currently around 5.2%.”
So what are the options for savers reaching retirement during the next couple of years?
They can, of course, do what they like with their money, such as taking it all out of the pension pot and putting it into a buy-to-let property. But that attracts severe tax consequences, with a 40% tax rate applied to much of the cash.
A current single life annuity, where the income dies with the person who takes it out, with nothing transferred to a spouse/partner, pays £5,209 for each £100,000 on a level basis – which means it does not go up in line with inflation. An annuity which goes up in line with the RPI index pays much less: just £3,242 at the outset, although this will rise.
Hargreaves reckons a better option is to buy a basket of equity income funds, where the average “yield” is currently 4.18%. In other words, you get £4,180 for every £100,000 invested.
But anyone investing in equity income funds needs to accept that they are subject to the swings and roundabouts of the stock market. Since 2000 there have been two 12-month periods where the FTSE All Share index has lost a third of its value, although it has subsequently recovered.
However, Nathan Long of Hargreaves says savers need to focus on the more reliable dividend history of companies, rather than their day-to-day share price.
So how do you go about organising a group of equity income funds paying 4% or so a year? There are plenty of low-cost DIY “tracker” deals. Vanguard’s FTSE UK Equity Income index fund yields around 4.5% and has an annual charge of 0.22%. But savers will have to pay to keep it on a “platform”, which results in another charge, thereby cutting the annual yield to just below 4%.
Alternatively, you can ask a financial adviser to set up a suitable combination of income funds (perhaps mixing bond and equity funds) – but be aware that the adviser will charge a fee, and the ongoing charge for being invested in actively managed funds may see you lose another 1% or so a year.