£500,000 is a lot of money, but is it enough for a comfortable retirement? If so, what kind of income could it generate? Below, our financial planning team at Vesta Wealth offers some answers.
Three broad approaches
There are three main ways to use a £500,000 pension pot to provide a retirement income.
Firstly, you could buy an annuity which is a financial product providing a guaranteed lifetime retirement income, typically linked to inflation. Secondly, you could keep your money invested and gradually draw down what you need (income drawdown). Finally, you could blend these two together e.g. using an annuity to cover essential costs, and using drawdown to cover luxury expenses.
This distinction matters because the route you choose can have a big impact on how far your £500,000 pension pot might stretch, and what your income might look like. An annuity, for instance, will likely provide a predictable, stable income, yet this income is likely to be lower compared to an income drawdown approach. However, income drawdown usually involves investing at least some of your money in the stock market, which can be volatile. As such, your retirement income may go up and down over the years, and you may even run out of money.
How much annuity will £500,000 buy?
An annuity is a financial product typically offered by an insurance company. Typically, the way they do this is to invest your money along with others into safer investments like bonds, which currently offer historically low interest rates. As such, annuities in 2021 are not as attractive as they were in the past.
In 2000, for instance, a £500,000 pension could have provided an income of over £40,000. Yet in 2021, the figure could be closer to £20,000 depending on your health and other factors. This is still a good level of income for many people, especially when your state pension is also factored in. However, others may need their pension pot to stretch further. Furthermore, it is important to remember that personal factors may make you eligible for better annuity terms, such as your age, health and location. Remember that annuities can be set up with many options, such as with or without a guarantee period, indexation, single or joint life etc., all of which must be selected at outset.
How much income will £500,000 achieve under drawdown?
With income drawdown, careful financial planning is needed to ensure two goals: achieving your desired level of retirement income and ensuring that this can be sustained over the long term. Here, we can run some calculations to try out some scenarios. For instance, suppose you invested the £500,000 and assumed an average return of 6% each year. After subtracting inflation at 2% and 2% investment fees/charges, this leaves you with a real return of 2%. In simple terms, this could allow you to take £10,000 each year without eroding the value of your pot.
If you want to take more, this may be possible, but you need to bear in mind the impact on your second goal, sustaining your pension pot. Taking £15,000 per year, for instance, could see your pot last until you reach age 99 – assuming you retire at 67 and invest your pot cautiously. A £20,000 annual income starts to see the longevity of your pension pot decline, assuming it is invested in moderate risk assets. Increasing the lifespan of your pension requires increasing your portfolio’s real return rate. This could mean finding ways to reduce investment fees with your financial planner and/or investing in higher risk assets which are more volatile, but which can offer higher rates of return.
Choosing what to do with a £500,000 pension pot
Your financial goals and risk appetite are both very important factors when deciding between a drawdown approach and/or an annuity. If you shun the idea of an unpredictable income when you retire, then drawdown may not be right for you. In some cases, it may be worth considering whether an annuity to cover essential costs is a good idea. However, if you are prepared to accept some investment risk and ultimately want any of your unspent pension to pass on to your children as an inheritance one day, then income drawdown may be a wiser option.
Bear in mind that the wider economic environment can also bear upon your choices. In 2021, for instance, interest rates are at historic lows. As such, many retirees are being forced to consider including more equities in their drawdown pot, which are higher risk but offer higher potential returns. Yet low interest rates are also pushing down the annuity incomes available from insurance company products.
Invitation
If you would like to discuss your financial plan and investment strategy, then we would love to hear from you. Get in touch with your Financial Planner here at Vesta Wealth in Cumbria, Teesside and across the North of England.
Reach us via:
t: 01228 210 137
This content is for information purposes only. It should not be taken as financial or investment advice. To receive personalised, regulated financial advice regarding your affairs please consult your Financial Planner here at Vesta Wealth in Cumbria, Teesside and across the North of England.