Pension pontoon: Stick or twist?
Retirees face the decision to take an annuity income now or wait, hoping rates will improve. By Chiara Cavaglieri and Julian Knight
Pension pots have paid the price of the Bank of England's attempts to support the failing UK economy. Ultra low interest rates and quantitative easing have left pensioners who rely on their savings with paltry returns and today, those approaching retirement are suffering under the low gilt yield environment.
When gilt yields fall annuity rates follow and those looking to tap into their pension pot now must decide if they should delay or risk determining their entire retirement income on such poor rates.
Annuity rates are so low that, according to new research, more than half of independent financial advisers recommend clients either delay taking their pension benefits or, alternatively, phase money into drawdown, in which the pension fund remains invested and the pensioner takes an income rather than purchasing an annuity. But is either a wise move?
Insurer Skandia's poll of nearly 1,000 advisers found that 29 per cent have told customers to use other savings such as individual savings accounts (ISAs) to provide an immediate income, leaving the pension fund untouched but available for drawdown as and when the situation improves. A further 22 per cent are pushing the drawdown option, so customers can benefit from any potential upturn in investment markets and gilt yields.
After changes made last April, people no longer have to buy an annuity by the age of 75, so more are able delay. This could mean that rates have a chance to improve; annuity rates generally increase as you get older (because they will pay an income over a shorter period of time) and if your health deteriorates, you may also be able to purchase an impaired life annuity for an improved rate. In the meantime, ISAs are a tax-efficient way to enhance your income and if you can also continue to pay contributions into your pension fund, you could significantly boost the value of your pot and get a much better annuity rate that way.
With rates at an all-time low deferral seems like a sensible option but experts say relying on annuity rates improving is a big risk.
"Annuity rates are awfully low at present but the conditions aren't right for these to rise significantly in the next couple of years," says David Gibson from independent financial adviser Gibson Financial Planning. "Clients who took their pension benefits a few years ago will be glad they did so – those taking equivalent benefits now could be up to 25 per cent worse off than before."
If deferring, you need to consider the impact of missing out on that income. For example, if you could secure an income of £1,000 a year now, but chose to delay for a year to see it increase to £1,100, it would take 10 years to make up that lost year's income.
"The delay of one year to your annuity will not significantly raise the pension you receive, but you lose one year's worth of income which you are unlikely to ever recover," says Adrian Lowcock from IFA Bestinvest.
Another concern may be EU gender legislation which could affect annuity rates for men. As rates were previously based on life expectancy, men have received bigger payouts because they are not expected to live as long as women, but the EU ruling means rates will now be equalised. The impact may be slight as the market has already had a year to adapt to the change, but the true fallout may only be realised later as insurers have until this December to make adjustments.
There are additional pitfalls with income drawdown. Those already using the option will have been hit by gilt yield falls, but are also restricted as to how much they can withdraw a year and again, that cap is linked to gilt yields. Moreover, charges may eat into the fund, reducing further the income when later taking an annuity.
"The cost of drawdown is higher than annuities, particularly given the need to review the plan regularly. We would typically only recommend phased or drawdown arrangements for those with pension funds over £250,000," says Alistair Cunningham from IFA Wingate Financial Planning.
If you do delay an annuity purchase you still need to consider where you invest your money. For those nearing retirement money is usually taken out of riskier equity investments and moved into stable investments such as cash and gilts, both of which are achieving low growth.
With all the pitfalls in mind, taking an annuity now could be the safest option for many and the good news is that there are still ways to improve your income. First and foremost, exercising the open market option will make the biggest difference. Never just take what's on offer from your pension provider; you could get thousands of pounds more a year by shopping around for the best possible rate.
"If you can't or don't want to delay, ensure you maximise your rate by looking at enhanced annuities (if you have a medical condition such as diabetes), impaired annuities (if you have a shortened life expectancy) and with-profits annuities," says Minesh Patel from IFA EA Financial Solutions.
With rates so low, with-profits annuities seem more attractive and could be a halfway house for those who are happy – and can afford – to take some risk. The idea is to invest your pension pot in a with-profits fund (investing in the stock market), with an income based on the expectation of a particular bonus rate (which can also be combined with impaired and enhanced rates). If the with-profits return is better than expected you can review and potentially increase the pension income on offer. Of course, if bonuses are lower than expected, your future annuity payments will fall too.
Gareth Reynolds, a financial adviser at Principal, says a fixed term, rather than a lifetime, annuity could also be an option. With this, instead of locking into a lifetime annuity you opt for an income for a given period of, typically, five years, at which point you can decide to carry on with another fixed term or take out a lifetime annuity. "Clients will be older with, perhaps, poorer health so this gives the flexibility of a plan that changes with clients' circumstances," says Mr Reynolds.
Expert view: Adrian Lowcock, Bestinvest
"Annuity rates are currently very low as they are based on 15-year gilt rates which are at historic lows. These will come under further pressure as the Government has increased its quantitative easing programme which may cause yields to fall further. However, annuities give pensioners certainty – an income they know is not going to change."
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