While annuities remain a popular way of funding retirement there are other options retirees can take to ensure their income levels continue to meet their needs for years to come. Samantha Downes looks at the options
As people spend longer than ever in retirement care needs to be taken to ensure this time is adequately funded. While the conventional annuity has long been the stalwart of the post retirement market, increases in the cost of living often mean retirees need a level of income that rises as time goes on. The possibility of needing long term care at some point in the future is also something that people need to think about and plan for in advance. Today's retirees need their retirement funds to last for longer than ever so what are the options available to them? This autumn the financial spotlight is expected to turn once again to annuities. Once regarded as a retiree's best bet of a secure income throughout retirement in recent years rising living costs have helped give annuities an inflexible and expensive reputation.
The Treasury's publication of a paper on the annuity market alongside last November's pre-Budget report was lauded as a breakthrough which could help to revolutionise the retirement income market. The Treasury invited the annuity industry to present its ideas on how annuities could be adapted to take account of the changing post retirement landscape.
Kevin Pacey, head of the Bank of Scotland Annuity Service says most people now face a "major" dilemma when it comes to buying an annuity.
"There is more choice than there used to be," he says. "For example should you take a flat-rate annuity that pays a higher income initially but which is eroded by inflation, or buy an escalating annuity that pays a lower rate initially but rises each year?"
Inflation-linked annuities are considered better value the longer you live and the higher inflation is and could provide a solution for those looking to maintain a healthy income throughout their retirement years. Pacey explains that at the age of 65, about 17% of men and a quarter of women can expect to live to 95; which gives inflation plenty of time to erode a pension income. He adds: "However, there is no simple answer as to the best type of annuity; it depends on the customer's individual circumstances such as age, health and risk profile and that is why it so important to take advice to find the best annuity for your retirement."
Ian Kerr, Aegon's head of marketing for annuities, claims a low awareness of the open market option also erodes the potential for more income.
He says: "There is a low awareness at the bottom end, where people are financially very unsophisticated. They have no idea they have options and think they have to stick with what they have got," he says.
Other types of annuities, such as Prudential with-profits annuity for protected rights present another option for retirees to maximise their income throughout their retirement years.
Before A-Day's legislative changes, those who opted out of the state pension scheme had to keep their National Insurance rebates - protected rights - separate from other pension contributions and because of this were only allowed to purchase a conventional escalating annuity.
Prudential said the removal of these restrictions last April, which included a requirement that protected rights were index-linked, meant it could offer an annuity that gave investors more flexibility.
Prudential UK, says advisers should be looking at all the annuity options available to their customers, rather than opting for a level conventional annuity. It argues that with-profits annuities do not promise full protection but they are invested in 'real' assets such as equities and property, making them a natural hedge against inflation. They also offer the potential of a rising income, which in itself can offset the impact of inflation so retirees get the most out of their savings.
Impact of drawdown
One of the most popular annuity alternatives is income drawdown. Research from provider Skandia appears to show that the popularity of income drawdown has increased since A-Day. According to the research sales of income drawdown measured by premium volume year on year increased 259% in the twelve months from April 2006. It's easy to see why this might be the case. While an annuity provides an income for life, no matter how long that might be, income drawdown gives the retiree the very real chance of increasing their retirement pot.
Nick Bladen, head of pensions marketing at Skandia says the option to phase retirement was more popular than ever. He adds: "The concept of forced annuitisation is clearly still unacceptable to a significant group of people, so advisers have a crucial role to play here in opening up other options. For many people, the freedom of being able to keep their pension fund invested and maintain greater control is an attractive choice."
However, the freedom of income drawdown does have a price. While the value of the fund can increase poor stockmarket performance also means it can also go down. Retirees also face the possibility of drawing out too much money and can deplete their savings.
Mark Andrews, chartered financial planner and managing director at Purplecircle Consulting, says drawdown limits are now at their most generous. "At the moment the maximum is 120% of the government actuary department (GAD) rate, which is itself based on a single person level conventional annuity," he says. "For some investors there is a real risk that if the market takes a dive, they could see their income plummet."
Andrews sees drawdown as an option only for those who can afford to risk continued stockmarket exposure, or who have a sensible amount to invest in cash based investments.
The third way
Fear over potential income drawdown mis-selling has acted as a catalyst to the launch of so called third-way products by US insurance companies, such as Hartford Life, and Met Life.
These products, which have been popular over the pond for many years, claim to allow investors to have the best elements of both annuities and income drawdown.
Hartford Life's Hartford Platinum product, has a feature called a guaranteed retirement income plan, (known as GRIP) which allows retirees to draw a minimum income for the rest of their lives, however long that may be.
John Enos, managing director of marketing and distribution at The Hartford says The Hartford's plan gives investors, up until age 75, the potential to lock in up to the first 10% of the increase in their fund value during the good years. Enos adds: "Also unlike an annuity, an investor can easily switch beneficiaries or transfer their fund value free of charge to another pension plan if their circumstances change. If you select Hartford Platinum's Guaranteed Retirement Income Plan they can guarantee your income for the rest of your life. You can even choose to extend this lifetime income guarantee to your spouse or partner."
Aegon Scottish Equitable International has also launched a third way product, although confusingly it is not pensionable and is offshore based.
The bond, known as 5 for Life invests in a range of investment funds made up of equities and fixed interest assets. The value of the plan moves up and down in line with the performance of these assets, minus charges and withdrawals. The policyholder can purchase this plan between the age of 18 and 80, and surrender part, or all, of their plan for the cash in value at any time. If the policyholder dies the plan will pay out 100.1% of the cash in value of the plan: it also offers guaranteed income of 5% of original premium per annum can be taken from the fund at any time from age 60 until death.
Mark Locke, an Aegon spokesman says: "The funds will still grow virtually tax free, with tax paid on death or when it is encashed. When guaranteed income is taken the majority of each payment will be tax free with a small amount being subject to tax at the marginal rate. This is the same tax treatment as income from a purchased life annuity."
He adds that the plan does not intend to wholly replace annuities: "The annuities also provide security of income of course. It's not a case of annuities 'bad' and 5 for Life 'good'. It's horses for courses - different consumers will have different risk profiles and 5 for Life neatly fills the gap between taking full investment and interest rate risk and taking none. By launching 5 for Life we are bringing new choice to the market."
So while annuities will continue to occupy an important place in people's retirement planning it is good to know that there are innovative options for those looking to boost their income. Increasing longevity has had an impact on how much income people can extract from an annuity but that income drawdown and third way products can be used to further boost this income over the long term. As a result today's retirees have the option to live through their retirement years in increased comfort.
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