The range of products available is growing.
There have been many changes to pension legislation that are likely to have significant impact on those planning to enter retirement. Where annuities were previously the default product for the vast majority of retirees, the choices over how to generate income have become much wider.
With such a myriad of options opening up, how do you find the best solution? How do you make sure your money works for you for as long as you need it? How do you create a sustainable retirement plan and make the most of the new flexible income options?
Retirement, therefore, needs some planning. With the average 65 yr old man expected to live another 21.4 years and the average woman, 23.9 years, this is becoming a very significant stage in life. And these figures are just averages – ie: as many as 1 in every 2 people will live even longer.
Questions to ask yourself
How much do you need to actually live on? The basics of course, but also those hobbies and small luxuries that make life a bit more fun…
What are your plans? Do you want to treat yourself and then settle down to a routine, or are you considering something more ambitious?
What other assets do you have that could assist your income plans, either now or in future? What is the situation with your mortgage and do you carry any other debts?
Do you want to make contingency plans? For the possibility of having to pay care fees, or for Inheritance Tax and other complications in passing on assets to loved ones?
Given the inability to make any accurate guess over your individual life expectancy, can you do anything to guard against the possibility of outliving your money?
The answers you come up with will at least start you on your way. At the very least, you will begin to understand what you really want to do and where you might need to think again.
Guaranteed Income for Life
"An annuity is a very serious business; it comes over and over every year, and there is no getting rid of it"
(Jane Austen, Sense & Sensibility, 1811)
There remains today only one way of guaranteeing how much income you can get each year for life. And its come in for some bad press recently. However, before you write them off completely, there is still some value in annuities.
Indeed, the principle of an annuity - ie: the promise to pay the policy holder a sum of money every year for as long as they live - has been around for centuries. They have evolved a little since Jane Austen's day and there are now many annuity providers you can go to with your pension fund.
But that basic principle still holds true - in exchange for your hard earned pension fund you will receive a specific, pre-agreed income, for life. Even if you live to be 150.
A period of bad press...
However, falling interest rates, rising life expectancy and an FCA investigation into some selling practices have all contributed to a background of ill feeling. And they do come with a risk - which is, if you die early, you may not receive back the full amount you paid in, and there will be nothing returned to your estate.
Despite all this, though, annuities are likely to remain a key part of retirement income planning. They come in a range of different shapes and sizes, and options also exist to try and minimise the extent of any loss should the worst happen. The following information therefore outlines some of the main features and options available to help you tailor one to your own needs.
Level income versus escalating income
A level annuity (on a single life – see below) is the cheapest annuity you can buy. This guarantees a fixed level of income for the rest of your life, with no changes, and therefore pays out the highest amount on day one compared with other options.
However, the average retirement can now last more than 20 years. Inflation will therefore start to eat into the buying power of that fixed income unless some provision is made to increase it.
An escalating annuity can help. They pay out less on day one but the escalation rate you choose – which can be 1% pa, 3% pa, in line with inflation or even higher – helps to secure some or all of the buying power of that income over the longer term.
When you take out your annuity, you can opt to include a minimum guarantee so that, even if you die early, at least a minimum amount of the original capital will be returned to your estate.
Such guarantees range from as little as one year to as many as ten years and will ensure your estate receives the balance between income you have received and the equivalent amount that would have been due over that guarantee period.
Single life versus Joint life
A single life annuity pays you an income for the rest of your life but then stops and will pay nothing more after death. If you are married or in a civil partnership, this could mean you risk leaving you partner without income in the event that you die first.
If this is the case, you may prefer a joint life annuity. This will keep paying out at least a percentage of the income if they live longer than you do. This percentage can range from perhaps 25% to 100% and will ensure that they can rely on at least some income even if you are no longer there to provide it yourself.
Variable, flexible and investment linked annuities
These annuities have some or all of their income payments linked to the performance of the stock market. The income they pay out would be set up front but then reviewed on a regular basis, usually every three or five years. As this review is subject to how investments have performed, that income could then increase but might also decrease.
Some of these annuities have underlying guarantees which will provide at least a minimum level of income regardless of stock markets – but check the details to see what assumptions are being made about markets and whether your attitude to risk is in line with their terms.
The average life expectancy for a male aged 65 is just over 83 years old. However, if you have certain lifestyle habits or medical conditions which mean your own life expectancy is going to be less than this, an enhanced annuity could increase the income available to you – or reduce the amount you need to pay if your required income is fixed.
That difference could be significant, so it is worth having the conversation about medical history and lifestyle with your adviser when looking for the best rate.
Fixed term annuities
Fixed term annuities pay you a guaranteed income with many of the above options available but only for a fixed period of time – usually between 1 and 10 years. This allows you to take an income from your money now but receive a cash lump sum back later which will allow you to shop around again for what might then be a better rate.
These annuities can be attractive if you believe, for example, interest rates will go up significantly or your health will deteriorate and open up the chance to get an enhancement.
However, be careful to check all the details of your expected income and lump sum, particularly for shorter terms. Charges for using the flexibility of such products need to be weighted up against the potential reduction in income that may be experienced if there are no changes in circumstances between now and the end of the fixed term.
Following the introduction of Pension Reform, we believe it is likely that annuities will develop further over the coming months and years. For example, in the US, there is fairly widespread use of deferred annuities and in the UK, talk of products which bring the annuity benefit of longevity insurance into line with some of the wider pension Reform flexibility. We will keep you updated on developments as we hear more but please do get in touch if you have any specific questions around your own situation.
Drawing down an income
Retirement today is a much more flexible thing than was traditionally the case. Notwithstanding the fixed date on which we will each qualify for our State Pension, nothing now forces us to retire at a certain age. Indeed, some of us don't necessarily want to retire at a set age.
And for the luckier ones amongst us, early retirement - or perhaps a switch from working for someone else to trying our hand at running our own business - is something we might want to try out well in advance of that rule of thumb age of 65.
Thankfully, along with that flexibility in retirement age comes a flexible product. Referred to as income drawdown – or more specifically as 'flexi-access drawdown' – it allows you to keep some or all of your pension fund invested while you draw an income from it. An income that you are able to set and which you can change each year if your income requirements demand.
Now, before we go on, drawdown is not for everyone. Unlike an annuity, there are no guarantees. The fact your fund remains invested means it is subject to market and investment risk. And there is therefore no guarantee that any income you take form that investment can be guaranteed to last as long as you do. There are ways to increase - or decrease the chances of it happening but you will never be able to be completely sure.
Income drawdown is therefore seen as suitable only for those who can accept such risk and have the capacity to suffer at least some level of loss should markets turn against them. This might include you if you, for example:
have a significant sized pension fund compared with your actual income needs
have more than one source of income you can benefit from
have a guaranteed income being paid from elsewhere already, perhaps a defined benefit scheme
have a significant estate and/or inheritance tax issue (within which income drawdown might - currently - play a key role)
Setting up a plan
If you decide drawdown is for you, you then have to decide how and where to invest the money. Your attitude to risk, your income requirements and your longer term requirements for any residual value will all help dictate what types of funds are most suitable for you. This portfolio should then be kept under regular review so that, if markets do move against you, you know early enough to make changes - perhaps reduce your income requirements or change your portfolio.
You can then keep your income drawdown plan for as long as you need it. This might mean you live off it forever, leaving any residual value that plan may have to your beneficiaries. Or it may mean that later in life you switch some of all of your money into an annuity, thereby securing at least some of your income for life.
In other words, you are not locked into drawdown. You can change your mind and switch out again at any time, albeit you do need to be aware that the value of your fund at this point may be lower than the value you started with.
In terms of tax, drawdown rules align with those of the other retirement options available. That means:
You can take up to 25% of your fund value tax free (and you have the choice whether to take this as a single payment or as a series of smaller amounts)
Any additional income or irregular withdrawals will then be taxed at your marginal rate of income tax for the tax year in which you receive the money
There is no doubt that income drawdown can be a complicated area of financial planning and one where a bit of professional help can prevent you making some potentially costly mistakes. At A&J Wealth, we have both the experience of the market and of the investment options availbale to help you avoid these mistakes and set yourself up for the comfortable retirement you deserve.
Consequently, if this is an area of interest for you, or you are simply looking to ask questions about it, please do not hesitate to get in touch.