Keeping options open

Pension savings form the core of the vast majority of people's retirement planning. However, whether it stems from a fear of putting all their eggs in one basket or needing that extra bit of income, people are also looking to extra means of funding retirement.

ISAs, bonds and even equity release are all options people look at when looking to supplement their retirement income. Why are people looking to these options and what role do they play in people's retirement planning?

"Pensions are a good way of saving for retirement but there has been bad press in the past," says Julie Mulvanny, head of business development, individual pensions at Prudential. "Pensions have attractive tax breaks and SIPPs and A-Day have done a lot to raise awareness about pensions but there is still a long way to go. The size of the average pension pot demonstrates that people as a rule don't understand how much retirement costs or how pensions work."

Pensions may be the best way for the vast majority to save for their dotage but there are several factors that make people wary of putting all of their savings into a pension.

"There has always been a level of tension between the attraction of tax relief against the fact that you can't access the money when you need to," says David Dunn, director of the Fidelity Retirement Institute. "Also the annuitisation issue has also mitigated against pensions."

What are the other options?

So where are investors looking to save their hard earned savings other than their pensions? According to Mulvanny there are a variety of options available.

"ISAs are a very popular choice as people know that if they put their money in and decide they don't like that particular product then they can take it out again," she says. "This control issue is probably one of the key misconceptions people hold about pensions. While you can't take your money out of a pension as you can an ISA you can change providers if you feel you can get a better deal from another provider."

Dunn agrees saying that "ISAs are undoubtedly the most popular way for people to supplement their pension income," but highlights that there are other routes to be explored as well.

"Insurance bonds have traditionally been very popular as they are tax deferred and that means you can take 5% of your original sum out every year tax deferred for twenty years," he says. "However, the other thing people forget about is mutual funds - they can still create a tax free income up to their capital gains allowance every year and leverage in their taper relief. It's possible that using bonds, ISAs and mutual funds will create a level of tax free income over and above the taxable income that comes from a pension."

The role of property

The rapidly rising property prices of recent years have prompted many people to say that their property is their pension. This can either be through the rental income of a buy to let or else selling the property to move into a smaller home.

"People need to look at their assets holistically and property will come into play," says Dunn. However, he warns that for those hoping to sell homes and downsize to a smaller property they may find things more difficult than they first imagine.

"While people are happy to say they will downsize in the years before retirement it becomes a more complex issue once retirement arrives," he says. "People are reluctant to sell their family home as even though they don't need the extra rooms all the time they still want their grandchildren to come and stay. Similarly they may well know everyone in the street and be reluctant to move as they want to keep that social network - it is a very emotional decision to make."

Equity release

As a result equity release is a solution that many more people are considering to help fund their retirement.

"The equity release market is growing rapidly," says Ali Crossley, business director, retirement income at Prudential. "It was worth just over £1bn at the end of last year but we think the market will be worth over £2bn by mid 2009. Equity release is here to stay and for a generation of people equity release and lifetime mortgages will be the answer for them. They might not be the only answer but certainly it is one of the options available."

According to Prudential research around 13 million people expect property to form some part of their retirement income with 2 million of those expecting it to form over half of their income.

"The fact is that the baby boomers have nearly £550bn in property and equity release can fit very neatly into an overall retirement strategy alongside ISAs and pensions," she says.

However, according to Billy Burrows, director of annuities at William Burrows Annuities, equity release still has some way to go before becoming a mainstream part of retirement planning.

"The thing that most people don't fully appreciate is the effect of compound interest and how taking equity release out too early can be very dangerous," he says. "Those products that make most sense to me are those with a fixed rate of interest. The dilemma is that if someone takes £50,000 from their house then they have £50,000 sitting in the bank and if they take too much income then they will run out of money but if they take too little then they won't get the full benefit. At least buying an annuity means they will get a sustainable cash flow and the knowledge that no matter how long they live they will get an income."

The key according to Crossley is increased product innovation; "We could see development where more than one product is wrapped together - annuities and equity release for instance," she says.

Such product amalgamation does seem the way forward, but it is not without its problems," says Duncan Young, managing director at Retirement Plus.

"When we did some research as to why people want to do equity release the need for a regular income was a popular choice," he says. "They might already have a certain amount of income coming from pensions and ISAs but need a little extra to augment the cash flow. The amounts we are talking about might only be very small - maybe about £100 per week. However, while the FSA hasn't ruled out investing equity release into an annuity they are simply not keen. Brokers need to be able to package up annuities and equity release in a way that satisfies FSA requirements. I think it's the right thing to do for those that just need that little bit extra."

Conclusion

So while there can be several components to a successful retirement plan some product innovation still needs to be put in place to full meet customer needs. While vehicles such as ISAs and insurance bonds will continue to play an important part in augmenting income the role of the pension and equity release needs to be developed further if they are to be as effective as they can be. Flexibility seems to be the name of the game according to Young.

"We are getting more inquiries about equity release and with the current demographics it is an area that should grow," he says. "However, it will only grow if the products are right and we have to get out there and provide what people need."

Dunn agrees with the need for flexibility saying that while pensions have a lot to recommend them there is still room for improvement.

"At the end of the day pensions are still excellent value, you get 40% tax relief if you are a higher rate tax payer and the fund grows tax free," he says. "However, annuitisation remains a real blind spot as people can't get over the emotion of giving money to an insurance company. The government ought to have some minimum compulsory annuitisation to ensure people don't become destitute but give people some discretion over and above that."

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