Peter Beavis discusses the role cash can play in a retirement income strategy.
Official Government statistics released in June showed that the UK economy had worsened again. Perhaps unsurprisingly, the Bank of England stepped in and pumped a further £50bn into the economy through its Quantitative Easing (QE) programme.
The idea is that QE will cut the cost of borrowing for individuals, companies and the Government. This is to encourage consumers to spend and firms to invest, but, whereas this may help to ease the pain in one area of the economy, for those who have just reached the retirement crossroads, the decision about whether or not to buy an annuity has just got tougher.
Three rounds of QE, volatile stock markets and the ongoing eurozone crisis have resulted in gilt yields reaching their lowest level since the Bank of England's records began in 1703.
Furthermore, if more investors start to regard Britain as a safe haven on a par with Germany or Switzerland, annuity rates could fall even further - currently investors receive no return at all on two-year German bunds.
As well as the challenge posed by current bond yields, there are two other aspects looming which mean that potential annuity purchasers need to consider their options carefully.
The first is gender neutral pricing, which is due to arrive in under six months, and the second is the impact of Solvency II. As yet, the real outcome of both of these factors is unknown but they do make the decision process more complicated at a time when the ‘Baby Boomer' generation is arriving at the retirement gate.
However, as is often the case, the economics of the current situation create opportunities in other areas. Amid all of this upheaval, banks and building societies have had to turn to retail investors to help raise liabilities as the wholesale markets have become more expensive.
This has meant the introduction of some very healthy personal fixed term rates which could potentially be used to meet the needs of retirees who do not wish to buy an annuity in the current market conditions.
Is there another way?
Acknowledging that the client's objectives and suitability are key to the advice process, one potential solution to the current financial turmoil might be to defer the decision making process for a period such as five years.
An adviser may look to fixed term annuities to solve the short-term issue but there is an alternative.
A ladder of fixed term deposits may in fact provide a better return and help maximise income over this period.
As an illustration of how this might work using a five-year term, a typical short term annuity with a fund of £115,943.92 and an income of £5,478.64 per annum would provide an annuity guaranteed at maturity of £94,483.46.
However, a cash management solution which combines a current account, for the monies from which the income payments will be made during the five years, and the remaining balance in a term deposit, using typical rates, could generate a fund of £107,735.49 at maturity. This is a significant difference in excess of £13,000.
Furthermore, the use of a ladder of fixed terms, providing the ability to move monies between term deposit options varying from 30 days to 36 months, allows for the same flexibility offered by a short term annuity but could provide a much larger balance at maturity.
There is also the peace of mind that in the event of the client's death prior to the end of the fixed term, their surviving spouse or dependents could access the monies, with interest paid on the deposit up to the date of death.
With many individuals looking for greater flexibility and security in their retirement options, as well as shelter from the current economic environment, a cash management solution could help them to achieve this and is an option that is an option well worth considering in today's challenging market conditions.
Peter Beavis is sales director at Cater Allen Bank
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