I read with great interest recently that Tesco are planning to launch an online comparison service for pensions. The plan is to make it easier for those approaching retirement to shop around for the pension annuity paying the highest income.
This is all very well, but annuities are not always the best means of securing retirement income from your pension pot. We will look at some of the alternatives for taking pension income later, but let’s look firstly at the situation in terms of pensions generally.
Last year around 450,000 people bought an annuity and the total sales of these reached £12 billion (source: Association of British Insurers). However, this same source reveals that between a third and a half of those who purchased an annuity did not exercise the Open Market Option and shop around for the contract that best matched their circumstances, preferring instead to take the quicker option of buying off the existing insurance company. As a result of this, it is probable that a high proportion of these clients not only failed to secure the highest level of income available, but they may not have purchased an annuity with the correct options attached.
In terms of options from your pension pot, there are now more variations and alternatives to the traditional annuity than ever before. For example, individuals who have health issues, or who smoke, could receive up to 40 per cent more income than a standard annuity, by opting for what is known as an enhanced annuity.
There are also investment-linked annuities, which do not guarantee the level of income, but have the potential to pay a higher income in the future depending on investment returns, thereby providing the prospect of some hedge against long term inflation without the often punitively low starting level of a conventional inflation-proofed guaranteed annuity.
Fixed-term annuities offer guaranteed terms over a pre-defined timescale rather than for lifetime and offer a degree of flexibility, but if annuity rates continue to fall they may not always prove to be a better alternative if personal circumstances or pension rules have changed further when the fixed term ends.
Away from annuities there is pension fund withdrawal, usually referred to as drawdown, which allows you to draw income from your pension pot without making the irrevocable decision to place your money into an annuity. It should be remembered though, that with this type of arrangement there comes a level of investment risk.
Individuals who are not comfortable with investment risk and need a retirement income now may not benefit by delaying annuity purchase in the hope of better rates in future, as annuity rates could remain as they are for a considerable period of time, and those who do choose to delay annuity purchase need to weigh up very carefully the costs of this decision, as there is the additional risk that the increased rate you may receive may never make up the income lost by delaying.
Whilst I have outlined some variations of taking retirement income, these are just examples and there are lots of viable permutations. Although choice is a good thing, it does make ensuring the right decision for your own circumstances more difficult than ever.
Income options in retirement is one of the most complex areas of financial planning and once a decision has been made it can often be irrevocable, so professional advice is essential. Armstrong Watson Financial Planning have many years of experience in this area, so contact us to see if we can help.
Phil Jackson, Financial Planning Consultant.
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