Martin Lewis compares pension annuity against drawdown
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Inflation has rise above 10 percent for the first time in 40 years, according to the Office for National Statistics (ONS). Recorded at 10.1 percent in July, people are now under significant pressure from the cost of living crisis.
The issue may be compounded for pensioners who have made choices about how to take their income.
One option which has steadily increased in popularity once more is the annuity.
An annuity provides Britons with a regular guaranteed income in retirement.
Often, instead of relying upon the peaks of the stock market, individuals can take their pension pot and buy an annuity at retirement.
It will pay out income either for life, or for an agreed number of years, and is thought to provide more stability in later life.
A drawback, however, is that it prevents the opportunity for potential investment growth – which is available through a drawdown option.
Although annuity rates have recently been improving, Tom Selby, Head of Retirement Policy at AJ Bell has warned inflation could wreak havoc.
He explained: “The impact of high inflation on those who have already bought annuities will depend on the type of annuity bought.
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“Some will have inflation protection baked into the terms of the contract, although this is often capped.
“If inflation exceeds the cap – which it will for many people this year – then your income is actually falling in real terms.
“This will no doubt anger people that purchased what they hoped would be an inflation-proofed income.”
This, however, is not the only type of annuity that will be available to Britons.
Mr Selby highlighted people typically purchase annuities with no inflation protection.
While in recent years this has not necessarily been an issue, with inflation skyrocketing again it could create a serious problem.
He continued: “It means these people risk being brutally exposed to surging prices.
“In the 2020/21 tax year around 85 percent of the 60,000 annuities purchased were ‘level-only’. This means they had no inflation protection at all.
“Just 15 percent of annuities bought were ‘escalating’, meaning they rise with inflation.”
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With a lifetime annuity, the decision is irreversible once the purchase has been made – and Britons will be unable to change their mind later.
As a result, in any economic climate it is worthwhile shopping around to find the best annuity deal.
The Government-backed website MoneyHelper states individuals should understand the various options available.
This will help them to know:
- When they will receive income
- How much they will get
- What they can protect
- Who they can potentially provide for when they pass away
The website added: “If you need help making sense of how and when you can access your pension pot, you can speak to someone from Pension Wise, a free service from Money Helper.”
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