It’s a big question… and like many others on the subject of retirement planning, you need to take a good long look at your own priorities and circumstances to come up with an answer.
A good place to start is by thinking about the difference between fixed spending and discretionary spending.
Fixed spending covers unavoidable monthly bills, like utilities, food and fuel. Other than trying to cut down or buy from the cheapest supplier, you don’t have much choice over whether you incur these costs.
Discretionary spending, on the other hand, is almost completely within your control. Costs such as eating out, going to the cinema, going on holiday or buying a new computer.
When deciding how to use your retirement savings, you should aim to always have enough money to cover your fixed spending. Eating, having a roof over your head and staying warm take priority over all else.
Fixed income – such as the state pension and ‘final salary’ or ‘average salary’ pensions (known as defined benefit pensions) – is an excellent solution for covering fixed spending. As well as paying a fixed level of monthly income, sources of fixed income also tend to rise with inflation, meaning that you can still afford to cover fixed spending in the future.
If you don’t have enough fixed income to cover your regular monthly outgoings, an annuity is a great way to top up your fixed monthly income. You hand over some or all of your retirement savings to an insurance company, and in return they pay you a fixed monthly (or yearly) income for the rest of your life.
It’s also possible to use income withdrawals from an invested pension fund to cover fixed spending, but you always run the risk that income from an invested fund could fail to meet your fixed spending needs. This can happen for a number of reasons, such as poor investment returns, taking too much income or simply living longer than expected.
Annuities are also a good choice for those who don’t like to take as much risk. Whilst keeping your fund invested and taking income withdrawals has the potential to provide a higher income, the opposite might happen and you could end up with less income than you would have got from an annuity. Some people are simply more comfortable with choices which are lower risk, even if they are less flexible.
The main downsides of annuities are:
You don’t need to buy an annuity with all of your retirement savings. It’s perfectly possible to keep some of your pension fund invested and buy an annuity with the rest. In fact, a blend of income withdrawals from an invested pension fund and income from an annuity can often provide the optimal trade-off between income security and taking risk to maximise returns on your investments.
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