How to fix your future income

ONE OF the few bits of good news for retirement planning has been the de facto approval of flexible retirement plans.

Until last November, anyone reaching retirement could take a tax-free lump sum out of their accumulated personal pension fund. They were obliged to use the balance immediately for a compulsory purchase annuity that would provide a taxable annual income for life.

Some compulsory purchase annuities provide a level income for life. Guaranteed annuities provide a level sum for life and guarantee to pay the dependents of anyone who dies within five years of retirement at least the balance of five years' money.

This is often a sensible precaution if the pensioner is in poor health or has dependent relatives, although inevitably the income is slightly lower.

A third option is to buy an annuity which rises annually to provide some protection against inflation after retirement, but in this case the initial annuity is smaller still. It takes seven years for an escalating annuity increasing at 5 per cent a year to overtake a level annuity.

The amount of annuity a specific sum will buy varies appreciably from one insurance company to another, so it pays to shop around, as long as your pension provider will allow you to do so without imposing a heavy transfer penalty.

However, the amount of annuity you will get for a given sum varies much more, according to when you buy it, the level of interest rates and, specifically, the yield on long-dated government stocks.

An annuity, after all, is really only the income from a lump sum topped up by a piece of the capital, the size of which will depend on how long an actuary thinks a person of your age and sex may live.

In 1990, when interest rates and the yield on gilt-edged stocks was high, a lump sum could buy an annuity of 15 per cent a year for a man aged 65 - that is, a lump sum of pounds 100,000 would buy around pounds 15,000 a year for life.

A year ago the same lump sum would have bought an annuity of only pounds 9,900, but as gilt-edged prices fell, so yields have risen over the past year. At present the same pounds 100,000 lump sum will buy around pounds 11,500 a year.

But anyone who waits for annuity rates to rise must also watch the value of the pension fund, which rises and falls with the value of investments. Rates will be lower for younger men who expect to live longer, higher for older men, and lower for women of comparable age to men, to allow for the fact that women tend to live longer.

But the timing trap remains the same, and few people can afford to defer retirement until rates improve.

Fortunately the Chancellor decided last November to approve the flexible pension option, which will allow anyone reaching retirement the option of taking some income from his or her pension fund (probably rather less than an annuity would provide), while deferring the purchase of an annuity until up to 75 years of age - thus giving everyone plenty of time to wait and choose a high point of the cycle at which to fix their annual income.

Winterthur Life has been quick on the draw with a flexible pension plan, but an increasing number of insurance companies will soon be offering a choice of flexible or phased retirement options.