A large number of people still hang on to the belief that companies grab the value of an annuity once the pension holder dies. The truth is, the ‘cross subsidy’ principle is applied to annuities. In other words, people who live beyond their expected life expectancy are subsidised by those who pass away before their time. Insurance companies like to sell annuities in groups so to speak. In every single group, there will be customers who live longer than expected and those who die sooner. There is no such thing as cross subsidy when it comes to income drawdown because each account is exclusive to one person.
If you go into drawdown before purchasing an annuity, this delay means you will miss out on cross subsidy. This effectively means that whatever investments you have made have to generate more profit to catch up to the level where it would have been at if you had bought an annuity on day one. This phenomenon is known as ‘mortality drag’.
If you elect to go into drawdown because you believe annuity rates will increase later on, you are taking a double risk. Annuity rates may actually fall and your investments may do likewise. Also, the more time you spend waiting to take an annuity, the longer you will be required to wait before you start receiving annuity payments. An annuity is the right choice for someone who believes they will live longer though of course there are no guarantees.