Are Dividends the New Annuity When Retiring
Published / Last Updated on 12/06/2019
At retirement you usually have a choice to buy a secure, guaranteed income for life (an annuity) or use flexible drawdown pension where your pot remains invested in a range of investment funds or direct holding stocks, shares and other assets to draw on. Are share dividends the new annuity?
Annuity rates are linked to Government Bond (Gilt) yields.
Gilts are where the government borrows money (public sector borrowing) from investors, pension funds etc and offer either an Index Linked or Fixed income (coupon/interest rate) that is guaranteed for the life of the gilt.
If you invest your pension fund to buy a guaranteed annuity income for like, usually the pension company will buy gilts with your pension investment to give them a guaranteed income for the term of the gilt to enable them to give you a guaranteed pension annuity income for life.
Share Dividends (in drawdown)
Dividends are a distribution of company profits to shareholders. Indirectly, these are also index linked as profits/prices rise (although no guarantees of future profit and therefore dividend). Your pension fund is allowed to own shares either directly or via an equity income type fund.
Example
Guaranteed Fixed Annuity for life at a rate of 5%pa or Guaranteed Index Linked Annuity for life at a rate of 2.0% pa.
FTSE 100 Company dividends are expected to average out at 5% pa in 2019.
Even at 4% pa, dividends may appear more attractive to people than annuities (linked to gilt yields) at say 2.5% pa.
The debate will enrage many who would prefer us all to take a lower risk, annuity based approach rather than a higher risk strategy where pension funds invest in shares inside a flexible drawdown to deliver dividend income that indirectly is linked to inflation as prices/profits rise with inflation but is not a guaranteed income.
