Think very hard before buying a pension annuity

How much do you need to retire these days? Of course it depends very much on what makes you happy. But for many people even a retirement pot of US$1 million may now not be enough to keep them in the style to which they have become accustomed.

This is the flip side of the money printing and low interest rate regime of the past five years. Invest $1m today in a pension plan and $40,000 to $50,000 is going to be your annual income, and not $70,000 to $80,000, as used to be the case. Factor in the recent inflation of housing and medical costs and it’s clear pensioners have really lost out.

That’s the position if you retire today and take an annuity. Why do that? Would it not be simpler to sit on your pot of gold and spend it gradually in the hope that times will change for investors? They often do spectacularly, and without much warning.

Buying an annuity when returns are as low as they are now is a terrible buy. You could be forced into it by the terms of your pension plan, but that would be the only sensible reason to proceed.

The expert advisers who put you into an annuity too early will still get their fees. Indeed, that might be why they are selling you an annuity rather than advising you to do nothing. Doing nothing is the prerogative of the rich, and for many people the only time in their lives when they actually do feel rich is when they get their hands on their pension pot. Keep your hands on it, and to begin with simply budget your cash withdrawals.

If you have $1m, then a $50,000 annual cash drawdown is going to last you more than 20 years. And how long will it be before markets deliver higher returns for investors again? We are living through an extraordinarily bad period for investors, but it is not going to last forever. Eventually savers will not save and that will force up investment returns to the point at which they will save again. Financial markets have moved in cycles since the dawn of civilisation, and for it to be different this time around would be nothing short of astonishing.

That might be less than five years away and yet you are being asked by pension planners to invest for two decades at today’s all-time lows. That’s simply bad advice.

One million dollars is still rather a lot of money in terms of what you can actually buy with it. You’ve got the cash. It’s the ridiculously low pension annuities that are an anomaly. That they are so far away from the previous long-term averages ought to be a red light warning to any buyer. Markets always revert to the mean level. You should instead manage your own money prudently, and that will help to make it last longer anyway.

This is a matter of personal choice and you should know your own personality by the time you retire. If you are simply a wild spendthrift with a lifetime habit of losing in speculation then you might still hand your cash over to a fund manager and be in a winning situation.

The trouble is that once you have bought an annuity you are usually locked into a lifetime agreement. Times could improve substantially for savers and investors and you would not benefit.

A recent Bloomberg poll showed smaller investors currently have a preference for real estate and gold, with equities a distant third. Diversify for protection and avoid bonds that are suffering from the same disease as your pension pot right now. Those low bond yields are your low pension income. Nothing is forever. Investing now for low-income sounds like a losing proposition.

Cynical readers who write to me sometimes point out that the financial sector robs its customers all their lives. Consider how much interest is paid on mortgages, credit cards and other loans, albeit for goods and services that you may find desperately important for your family’s well-being at the time.

Why allow this to continue into your retirement? If you’ve been prudent enough to amass $1m in your lifetime then let managing it be a small job for you in your retirement and cut out the middleman. Enjoy yourself modestly on a reasonable budget and see those unfortunate enough to buy annuities now live to bitterly regret it in the near future. Sadly there is going to be a generation of very grumpy old men and women.

Peter Cooper is the editor of ArabianMoney.net

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