I have a pension and I want to eventually transfer this into a drawdown arrangement.
As a general rule, do drawdown pensions have higher management costs? At the moment my scheme has a management cost around 1 per cent.
I am trying to weigh up buying an annuity, or using drawdown at around 3 to 4 per cent per annum.
If the drawdown management costs are high from the pension provider then it makes the drawdown arrangement less attractive and the annuity more attractive. I’d be grateful for your views on this.
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Drawdown or annuity? This reader is trying to decide how best to manage their pension, and is worried about how much they might have to pay in management fees
Steve Webb replies: Let me address first your question about drawdown costs, before offering some thoughts on how far such charges should affect your choice between going into drawdown and buying an annuity.
The costs of drawdown products can vary considerably, but in many cases they will be higher than you have been paying for your existing pension.
This will be especially true for those who are currently saving via a workplace pension, into which they have been automatically enrolled.
Provided that they are in the ‘default fund’ of that arrangement, the charge cap means that they will be paying a maximum charge of 0.75 per cent and often considerably less.
In most cases, if you take that pension pot and shop around for a drawdown product you will end up paying higher charges.
Some personal pension providers will, however, carry over the charge level from your workplace pension into your drawdown pension provided that you stay with them.
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One starting point to compare drawdown products would be the website of the government’s MoneyHelper service, which has a specific tool to help you look at your different options if you are thinking of going into drawdown.
This includes information about charges. However, some in the industry have criticised the site for not taking enough account of factors such as past investment performance, target returns and ease of withdrawal.
An important thing to be aware of when looking at drawdown charges is that you may face more than one type of charge.
In some cases, there will be a setup fee when you start the product and an ongoing product fee, but there could also be charges if your product is hosted on an investment ‘platform’, and there may be charges based on the number of withdrawals that you make.
In addition, some providers may charge you a flat fee for running the product whilst others may charge you a percentage based on the size of the pot.
Drawdown or annuity?
On the bigger issue of the choice between drawdown and annuity, the level of charges in the drawdown product is only one factor and, arguably, not the most important one.
A key factor is your attitude to risk and your ability to cope with loss. If someone has just one pension pot to support them through retirement (apart from their state pension) they may be in a difficult position if the value of that pot were to fall sharply through market movements.
In such a situation, they may feel more comfortable using some or all of the pension pot to buy an annuity in order to give a guaranteed – if potentially modest – income.
On the other hand, if they perhaps have a final salary pension and a state pension to provide a good secure base level of income, they may feel more able to take some investment risk with their pension pot and stay longer in drawdown.
There are also pros and cons of using your pension pot to buy an annuity.
At first sight an annuity looks like it will give you a high level of certainty, and it is true that you would be immune from the ups and downs of the stock market if you buy an annuity. You would also be guaranteed that the payments would last as long as you live.
But most people who buy an annuity buy one with no provision for a spouse or partner after their death, and with no protection for inflation.
Those who bought a flat annuity of this sort a year ago will have seen inflation erode their spending power quite dramatically. Although the cash amount of the annuity is guaranteed, the real spending power of the annuity is not, as this depends on the level of inflation.
In addition, if you were to die, a ‘single life’ annuity would die with you, whereas the balance in a drawdown pot would pass to your heirs.
A further factor to consider is that even if you go into drawdown now (or even leave the money accumulating in your existing pension pot) that doesn’t stop you buying an annuity at a later age if you wish.
There is a growing body of research which suggests that the value-for-money from an annuity may rise as you get older, and that even those who go into drawdown at retirement may wish to think of converting some of that pot into an annuity later on.
I hope I have shown that the choice between annuity and drawdown should be about more than charges, important though they are.
For more help and guidance you can get a free appointment with the Government’s ‘Pension Wise’ service.
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.
Steve left the Department of Work and Pensions after the May 2015 election. He is now a partner at actuary and consulting firm Lane Clark & Peacock.
If you would like to ask Steve a question about pensions, please email him at [email protected]
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 MoneyHelper, a Government-backed organisation which gives free assistance on pensions to the public. It 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.
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