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BLOG: Retirement income choices

Kit Klarenberg
Written By:
Kit Klarenberg

“Let me be clear. No one will have to buy an annuity.”

George Osborne’s words from his Budget statement of 19 March 2014 heralded a new era for pensions. Greater freedom to take income and pass on unused funds have invigorated the retirement market and will lead to more choice for consumers.

The April changes offer an opportunity for innovation, some of which is already starting to emerge. However, that does not necessarily mean that new products are required in order to meet consumer needs. For many the current product suite will be sufficient however, for those looking for something different, more solutions are expected to emerge as the year progresses.

Traditional annuities will remain suitable for many savers, especially where guaranteed lifetime income is required or simplicity is desired. Additionally, annuities may offer smokers or those in poor health higher rates of lifetime income. The new rules allow for greater flexibility around how income is paid by an annuity. For example, the income payment may mimic the traditional model for retirement expenditure, offering higher income at the start, lower payments through the mid-retirement years which increase again in later life. However, income rates and options are set when purchasing the policy, meaning that annuities will remain the least flexible of all retirement options.

Fixed-term annuities provide guaranteed income for a short period, providing a lump sum at the end, which can be reinvested in another retirement income solution or taken as a lump sum. These are useful when income is needed, but the investor does not wish to make a final decision immediately. Shorter term guaranteed income can meet a shortfall until the saver starts to receive income from another pension, or if they believe their circumstances may change in future. However, savers using fixed-term annuities will share some of the limitations suffered by annuities, plus may find the solutions available at the end of the term are not as favourable as expected.

Many providers will look to offer a range of solutions to provide annuity-style income security, but through income drawdown. Unit-linked guarantees underpinning drawdown plans have been available for some years, but alternative investment solutions are now emerging; for example, using multi-asset funds or longevity units to provide some certainty over income and how long the fund will last. Alternatively, some funds could be used to purchase short-term income products at periodic intervals, leaving the remainder of the fund untouched and still invested.

Where retirement income is not a priority, savers can continue to look for investment growth and using the new succession rules to pass on remaining pension funds. Some investors may choose self invested personal pensions (Sipps) which offer greater freedom over how funds are invested, when compared to other retirement products, including holding commercial property within the pension. However, the investment element of drawdown carries with it the risk that fund values may go down, or that taking too much income may lead to the fund running out too early. Investors using any form of drawdown must be clear on the risk that accompanies the flexibility.

Choosing the right retirement solution is far from straightforward, and it may be possible that no single solution is perfect.  If in any doubt over the best solution, investors should seek professional assistance from a financial adviser or look to Pension Wise (www.pensionwise.gov.uk) – a government service set up to help savers understand their new options available after 6 April 2015.