Two fundamental strategies are available to those in the post-retirement market: annuities or income...
Two fundamental strategies are available to those in the post-retirement market: annuities or income drawdown. Currently a little over a third of people use income drawdown, while the rest of the market opts for annuities.
There are, however, well-documented problems with annuities. Fundamentally, since pensioners are living longer than ever before, annuity rates have fallen significantly. This has spurred calls for annuity reform. Indeed, there are already many encouraging signs of annuities being improved.
The introduction of impaired-life and limited-life annuities has presented the option of much better rates for those in the higher risk health category. This selective annuity process has led to a much more efficient and egalitarian market.
However, in addition, phased retirement can provide a degree of mitigation for adverse stock market conditions by allowing the investor to build up a portfolio of annuities over 25 years and retain control over the death benefits of the remaining unvested fund. By phasing the purchase of annuities, the investor is effectively drip-feeding equity-based pensions into annuities. This creates a similar effect to pound cost averaging, where stock market fluctuations can be somewhat mitigated.
Phased retirement also has the advantage that unvested segments of a pension fund can be written in trust for beneficiaries, who can take these as tax-free cash. That said, phased retirement is still subject to the vagaries of the annuity market, and with increased longevity the trend in rates is still likely to head downwards.
The only viable alternative to annuity based retirement, however, has serious problems. Income drawdown generally has a minimum investment limit of around £150,000 which puts it beyond the reach of many investors. Realistically, however, income drawdown is best suited to those who have £250,000 or more to invest.
However, income drawdown is fundamentally an investment product, and has been adversely affected by plummeting equity markets in the same way as other investment products. In these market conditions, income drawdown has become far less attractive than annuities, which offer set returns. Indeed, the fundamental advantages of income drawdown ' income flexibility, investment control and control over capital for death benefits ' are negated by falling equities.
Phased drawdown is also reliant on good asset management, making it subject to equity performance. It also does not guarantee the income that annuities can offer, although it increases the death benefits and can be combined with a discretionary trust for inheritance tax purposes
All the options in the pensions market look decidedly difficult, given the reliance on the performance of underlying assets ' the majority of which are companies. Governance problems, overpayment of directors and a move away from delivering share and stakeholder value are severely affecting company performance. With this in mind, the only option is for people to save more, combined with Government reform of corporations. By post-retirement, it is however too late.
Charles Ansdell is head of corporate
communications at Inter-Alliance
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