What is Guaranteed Drawdown?
- Where did it come from?
- How does it work?
- What sort of guarantees are available?
- How much guaranteed income will I get?
- Why would I want to do it?
- What are the advantages?
- What are the downsides?
- Any final thoughts?
Guaranteed Drawdown is very often considered a halfway house between the constrained security of a Conventional Annuity and the risky flexibility of Flexi Access Drawdown. It will give you the security of a guaranteed income for life (like an Annuity) but still give you maximum flexibility and control of your capital (like Drawdown).
Where did it come from?
A recent innovation in the pension planning arena from the USA has been the arrival of variable annuities, usually referred to as Guaranteed Drawdown.
It is important to note this new US style “variable” Annuity bears little resemblance to the traditional annuity recognised in the UK. It is best described as a conventional Income Drawdown product, underpinned by different types of guarantee.
How does it work?
There are variations, dependent upon which pension product you chose. For example; you may elect to fund your guaranteed income by using a part of your fund for Annuity purchase at outset. Or more likely the pension product provider will underwrite your income guarantee by engaging a Counterparty and purchasing derivatives to offset any falls in your fund value. It all starts to get very technical and different products work in different ways but this aspect is very important as the guarantee is only as good as the institution providing it!
What sort of guarantees are available?
- Your fund is guaranteed not to fall in value regardless of underlying investment conditions.
- Minimum accumulation benefit, where funds are guaranteed to accumulate to a certain amount by a particular point in the future.
- Minimum income benefit. Where from a fixed point in the future, it is guaranteed that regular withdrawals can be made at a specific level, even if the fund itself subsequently runs out of money.
- Minimum death benefit, where a named beneficiary is provided with a specified sum in the event of the insured person (ie you!) dying. This can ensure a guaranteed level of income for your spouse or a lump sum for your children.
By combining and tweaking these objectives, a plan can be designed that meets your individual needs – and it can give you the flexibility to modify your choices in the future as your circumstances change.
How much guaranteed income will I get?
This is usually quoted as a percentage of your fund size and will depend upon your age and if you want to provide income for your Spouse/Partner after your death. Below are some examples of percentage currently being used by one Guaranteed Drawdown Pension provider.
|Age at outset||% of fund value|
Why would I want to do it?
It is a compromise and like all compromises it comes at a cost but it keeps your options open whilst having the opportunity to provide you with peace of mind of certainty of income and defers you having to make a ‘once in a lifetime’ decision regarding your pension fund. Also many providers will allow you to opt in and opt out of the guarantee as and when you want giving you all the flexibility of full Drawdown
What are the advantages?
- The guarantee of a fixed level of income/ death benefit/lump sum.
- Potential for increasing income by sharing in investment growth.
- Flexibility to change your income requirements in the future.
- Avoids ‘once in a lifetime’ commitment of conventional annuity purchase.
- Potential to leave your fund as a lump sum to beneficiaries other than your spouse.
What are the downsides?
- All guarantees come at a cost and have to be paid for explicitly.
- There may also be the ‘opportunity cost’ of not enjoying the full value of any investment growth due to charges.
- Charges and early surrender values can be prohibitive.
- Variable annuities are relatively new and some designs are complex.
- Your starting income will be lower than a conventional annuity.
- Without growth your income may never reach the level of a conventional annuity.
Any final thoughts
The word “guarantee” is always attractive but nowhere more so than when it comes to an income for life! BUT remember guarantees come at a price but in times of turbulent markets you may feel that is price worth paying. Like any retirement income option it is a compromise and a case of determining what your priorities are; why not make a list to see just how important the security of a guarantee is to you?