What income can a £500k pension provide? | Drawdown vs Annuity

What income can a £500k pension provide?

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    To determine what income a £500k pension can provide, factors like retirement age, desired income, investment returns, and life expectancy must be considered. It also depends on whether the pension income is taken via drawdown or an annuity. Careful planning and professional advice are crucial.

    This article will attempt to answer the question of how much retirement income you could take from a £500,000 pension using either Flexi Access Drawdown or an annuity. We’ll use several retirement ages to show you the effect retiring earlier can have on the amount of income you can take from your pension.

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    Income from a £500,000 pension using drawdown

    As you can take as much income as you like with Flexi Access Drawdown, it’s hard to say exactly how much income you can take. One way to do this is to carry out a cashflow forecast but this software is very expensive and if you aren’t a financial planner or using a financial planner, this might not be possible for you. 

    A simple approach to give you a rough and ready idea is to calculate what income you can take each year that would extinguish the drawdown pot at a certain age. To make this realistic, one option is to set it so the pot is extinguished at a realistic and conservative age for life expectancy.

    Let’s make a few assumptions:

    1. We will use Duncan in our example, and we will assume his life expectancy is age 92 we will set it so the drawdown fund pays out the same amount each year so that the pot is extinguished at this age. 
    2. The income that is taken from the outset increases by inflation so that it maintains its purchasing power. For inflation we will assume 2.50% a year.
    3. We will assume the drawdown funds that are not taken as income increase  by 5% and this is net of all fees.
    4. We will assume he is entitled to the full state pension of £11,500 per year.

    Although the whole point of drawdown is the flexibility and the ability to change your income and virtually nobody will take the same amount of drawdown income each and every year, I think for the purposes of looking at the sustainability of the income, this is one of the simplest and easiest methods.

    For somebody who retires at 55 and 60 and plans on taking significantly more from their pension before the state pension, this method isnt really appropriate. For this scenario, we will turn to a cashflow planning tool to see how the effect of taking more income earlier in your retirement can have. 

    Income from a £500,000 pot at age 66

    However, We’ll start with Duncan who retires at age 66 and work our way backwards. If Duncan retires at 66, the same age as when he is eligible for his state pension and his expected life expectancy is aged 92, this is a retirement term of 26 years.

    As this is the shortest time in retirement of the examples, this means he can take the most amount of income. And just to hammer the point, with the simple rough and ready example for age 66 only, we are working out how much income he can take from age 66 each and every year that increases by inflation, that will extinguish the pot at age 92.    

    Duncan could potentially take a starting income of £26,208 per year that increases with inflation for the pot to be completely extinguished at age 92.

    By age 74, the pension would still be worth over £450,000 that his beneficiaries could potentially inherit if he died, tax free. 

    If we assume Duncan was entitled to the full state pension of £11,502 per year, this is a retirement income of more than £37,710, without accounting for a spouse or partners retirement income.

    Type of Income Amount Per Year (£)
    State Pension£11,502
    Drawdown Income£26,208

    If we look at the Retirement Living Standards survey and the figures they quote an average UK retiree would need to retire, this would give Duncan a very comfortable retirement, without even accounting for a spouses retirement income, if he has one.     

    Income From a £500k pension at age 60

    Ok so Duncan wants to see how much income he can take from his £500,000 pension at age 60. He plans on taking more income from his pension from age 60-67 before his state pension kicks in.

    The method we used earlier doesn’t work aswell. The method earlier assumes the spending is nice and linear and remains the same throughout retirement. The reality is that this is far from the case.

    Most retirees usually spend more during the active years of their retirement or before the state pension kicks in, it will then naturally decline as they are no longer able to do the things they used to do such as holidays and cruises etc and then the spending may increase as their health deteriorates etc.

    With that in mind, for this example of Duncan retiring at age 60, we will assume his expenses remain the same until age 80, at which point his expenses reduce by 25%. We wont model care fees which you could argue is the wrong thing to do, but his expenses have remained relatively high until age 80 which offsets this to some degree as many retirees, in my experience, would be spending much less at this point.   

    Under these assumptions, Duncan could take a starting income of £2,535 per month (£30,420 per year) that increases by inflation, with the pension fund running out at age 90.    

    Sequence of Returns Risk – Retiring at age 60 with £500,000 Pension

    The scenario above assumes the growth rate is a nice steady 5% per year. The reality returns are a lot lumpier.  

    I always like to stress test a cashflow forecast against a doomsday scenario to highlight the effect of the sequence of returns risk, which is the idea that the timing of returns matter.

    For example, if you retire just before a stock market crash, this has a much more negative effect compared to somebody who retires and enjoys stellar investment returns, because not only are you now taking an income from your portfolio, but you are taking an income from a falling value.  

    To model this type of event we have included a scenario which models the returns of the UK stock market during the banking crisis of 2007-2009.  

    Using this scenario, if Duncan was to retire at age 60, and took the same starting income of £2,535 per month, his pension would run out of money at age 74!

    Using a safe withdrawal rate to estimate income from a £500,000 Pension

    Another popular option is to use an arbitrary rule of thumb such as the 4% rule. This involves taking 4% of the starting pension each year and adjusting it upwards each year by inflation. However, you will see many commentators on a quick google search suggesting 3% is more appropriate whereas others would say you will be fine with a withdrawal rate of 5%.  

    The withdrawal rate is important as a higher withdrawal rate will mean you can take more income however, all else being equal a higher withdrawal rate increases the chance of running out of money:

    Safe Withdrawal Rate %Amount of Income £

    The issues with this are again it doesn’t really fit the scenario of someone who plans on taking more income to spend on holidays during the active years of there retirement or simply before the state pension kicks in and then reducing it, and there is no guarantee that the 4% rule or any other variation doesn’t mean you wont run out of money if investment returns or stock market crashes aren’t much worse in the future. 

    What annuity income could I get from a £500,000 pension pot?

    With a lifetime annuity, you essentially swap your pension fund in return for a guaranteed income that is paid for life. Once you die, the annuity usually dies with you. It is possible to add inflation protection and also a survivor’s pension so that the income maintains its purchasing power and can provide a pension for your loved ones. However, this usually reduces the starting retirement income. 

    As the income is guaranteed for life, there is no risk of the pot running out. So it’s a sensible option for those who are uncomfortable with investments and market volatility.

    Annuities fell out of favour after the pension freedoms were introduced in 2015 and because of the ultra-low interest environment that existed right up until 2021. You can see how the potential income from annuities has increased dramatically as interest rates have risen in recent years to combat inflation:

    Annuity rates chart based on figures for September 2023

    The amount of annuity you can achieve depends on:

    Your age. The older you are, the better the rate tends to be, as the insurance company statistically will have to pay you the income for a shorter period of time.

    Your health. If you have any health conditions, you may be entitled to an enhanced annuity, leading to a higher annuity rate. This varies between insurance companies. 

    Different types of annuities:

    The type of annuity you choose from the outset affects your income. Here are two examples.

    • Annuity 1 – Single Life annuity with inflation protection.  
    • Annuity 2 –  Joint annuity with a 50% survivor pension, increases with inflation and has a 5-year guarantee.

    As with the drawdown example, we will give examples of an annuity purchased at ages 55, 60 and 65 to show you how the age at which you retire can affect the starting income. Both examples assume the person is in good health. The figures will be based on the whole pension fund and assume no tax-free cash is taken for simplicity.

    How much annuity income from a £500,000 pension

    Age 55:

    Type of AnnuityIncome PAAnnuity Rate
    Annuity 1- Single Life Annuity£30,5946.19%
    Annuity 2- Joint Life Annuity£15,9233.18%

    Age 60:

    Type of AnnuityIncome PAAnnuity Rate
    Annuity 1- Single Life Annuity£32,7036.54%
    Annuity 2- Joint Life Annuity£18,3543.67%

    Age 65:

    Type of AnnuityIncome PAAnnuity Rate
    Annuity 1- Single Life Annuity£36,9697.39%
    Annuity 2- Joint Life Annuity£22,3944.48%
    Source: Ires exchange as of 17/05/2024

    You can see how an annuity’s extra ‘frills’ can reduce the initial amount of income.

    The age at which you retire significantly affects the level of annuity income that you may be able to get when you retire. If you retire at 55 compared to someone aged 65, your annuity income could be as much as 20% lower. 

    It is worth mentioning that annuity rates change all the time, as we saw in the graph earlier.

    How does taking a tax-free lump sum affect my pension income?

    You can usually take 25% of your uncrystallised pension pot tax-free. However, the lump sum will reduce your pension pot and, therefore, reduce the amount of income available to you in the future.

    If you are thinking of taking some of your tax-free cash, you should always bear this in mind.

    Start building your retirement income with Heritage Financial Planning

    If you have a defined contribution pension, there’s no right or wrong answer as to whether you should consider taking an income via pension drawdown or buying an annuity. It very much depends on your circumstances.

    Another option gaining popularity is to take an annuity out to cover your essential expenditure and then use drawdown and its flexibility to tailor it around your discrepancy expenditure.

    If you are considering retirement and your options, seeking professional guidance and speaking to an independent financial adviser is always a good idea.

    Contact Heritage Financial Planning and start taking control of your retirement plans today.

    The value of investments and any income from them can fall as well as rise, and you may not get back the original amount invested. Past performance is not a reliable indicator of future performance and should not be relied upon.

    Annuity rates may change in the future, which could reduce the potential income. The figures in this article are based on various assumptions, which are impossible to control, such as life expectancy, growth rates and inflation. If the figures are much worse, this can affect the sustainability of your pension fund.

    Picture of Alex Norman-Jones​

    Alex Norman-Jones​

    I am one of the founders of Heritage and I am highly motivated to deliver bespoke financial planning solutions to my clients.

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