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Making your savings last a lifetime

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Unlike annuities, which provide a guaranteed income for life, taking income directly from your pension fund brings the uncertainty that your income will run out before you do.

On the other hand, by choosing to keep your savings invested, you can potentially make your money work harder and take income more tax-efficiently.

Unlike buying an annuity, this method of taking income in retirement requires ongoing management of your investments.  And although income withdrawal also carries the risk of running out of money early, it is possible to reduce those risks by actively managing your investments and the withdrawals you are taking.

How long is a lifetime?

If income withdrawals are expected to last a lifetime, it would be ideal if we knew how long that would be. Although no one can predict their life expectancy with complete certainty, considering whether you are more, or less, likely to live into your nineties is helpful in planning the amount of income you can afford to withdraw.   

Research published by Aviva last year shows that people under-estimate how long they are going to live.  Men approaching retirement thought that, on average, they would live 15 years after their 65th birthday – to age 80. Women thought they would live another 19 years or to age 84.

Although women were more realistic, both men and women underestimated how long they were likely to live. The UK average suggests that 65-year-old men should expect to live another 18.4 years (to age 83 and a bit) and 65-year-old women another 20.9 years, just short of their 86th birthday.

But relying on the national average could result in people underestimating their lifespan. For example, figures from the Institute and Faculty of Actuaries showed that if we focus solely on people who have bought an annuity, over 31% of men will live to be over 89 and 36.9% women over 90. This is significantly higher than the UK average. So, when planning your retirement, it’s important to understand what factors could influence how long you live.

What factors influence how long you will live?

  • Wealth is the strongest indicator of how long you are likely to live.
  • How long your parents lived – if your parents lived into to their late 80s or 90s, there is a good chance that you will too.  
  • Whether you smoke.
  • How healthy you are at retirement, and how healthy your lifestyle is – for example what you eat and how much exercise you get.
  • Where you live. For example, using national average life expectancy data, 65-year-old men in Harrow, Middlesex, live six years longer than men of the same age in Glasgow City – and 65-year-old women in Camden, London, live five-and-a-half years longer than women of the same age in West Dunbartonshire.

If all these factors are positive, there is a very strong chance that you will live into your 90s and you should plan to make your money last that long. For example, if you retire at 60, your retirement savings may need to last for 35 or even 40 years.   

At what age does it make sense to consider annuities?

While drawing income directly from your pension fund has the potential to deliver a higher retirement income than an annuity, this potential reduces as we age.

The reason for this is that the income paid by an annuity includes a contribution from three sources:

  • The capital invested
  • Any investment return earned on the capital invested
  • Any remaining capital left by annuitants who died early

When drawing money directly from your pension fund, your income comes only from the first two sources; a return of your capital and any investment return on that capital.

This becomes more important as we age, because inevitably more people begin to die.

By our late 70s or early 80s, the additional ‘return’ that annuities earn (from capital left behind by annuitants who have died early) makes it difficult to match the overall return an annuity offers, even if investing in higher risk investments. 

So, if the main reason for keeping your fund invested is to draw an income, then switching to an annuity at a later age may make good financial sense, particularly for those whose health and life expectancy is better than average.

However, drawing an income from your pension may not be the sole reason for keeping it invested. For example, some people may want to use the fund to cover unexpected large bills such as building work or care costs, or as a way to pass an inheritance to their children or grandchildren. In these  cases, switching to an annuity is less relevant. 

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