Billy Burrows examines what to look for when making decisions on retirement income
Much has been written about annuities and the other retirement income options in the recent past and much of it has centred on a few well-known themes including the need to shop around, the problem of low annuity rates and the importance of considering the investment-linked annuities and drawdown.
Good as the media output on annuities is, many articles leave individual clients with a sense that all they have to do at retirement is to shop around for the best annuity rate, especially enhanced annuities and they will have done the right thing.
However, making the right decisions at retirement involves much more: it involves a decision-making process that encourages individuals to consider a number of key issues before deciding which options are most suitable for their circumstances.
In general terms, most people approaching retirement should consider three questions:
1. When is the right time to start taking pension income and/or take the tax-free cash?
2. What type of annuity or drawdown policy and which options are most suitable?
3. Which product provider is offering the best terms?
One of the problems with many people’s approach to retirement is that they immediately go for the highest level annuity income without considering the other issues. So how can these important questions be considered in a way that is client friendly, fully compliant and cost efficient?
The answer lies in taking a step-by-step approach. There are essentially three steps that every individual and specialist consultants should follow before arranging an annuity or drawdown:
1. Understanding the key issues
2. Comparing all the relevant options
3. Deciding which options are appropriate for individual circumstances
These steps are linked by a number of important actions. For example, before knowing which options to get quotes for, the individual’s objectives need to be established. Before a decision is made suitability has to be considered.
Step 1: Understanding the key issues and options
One way of doing this is to consider the various risks or future unknowns that need to be taken into account. Nobody knows what will happen over the next 20 to 30 years and there are many future unknowns including:
- How long the individual will live?
- What the future rate of inflation will be?
- Will equity markets go up or down?
- What will happen to interest rates?
- Will their health deteriorate?
If the wrong decision about the choice of annuity or drawdown is made, the individual will be stuck with the consequences for the rest of their life, as they will not be able to make any changes in the future.
For example, if annuity rates were to increase in the future and an individual has locked into a guaranteed annuity at today’s low rates, they would not be able to take advantage of the higher rates in the future.
Equally, the level annuity option may seem a good choice at the outset, but if inflation was to increase in the future many may have wished they had an increasing income.
Step 2: Compare all relevant annuity & drawdown options
This is probably the most important part of the advice process because it is only when clients see the comparison of the pension incomes from the different options that they begin to understand their choices.
However, it is important that any annuity quotations or drawdown illustrations are obtained on the correct basis and presented in a clear and easy to understand way so people can make an informed choice.
Most advisers present annuity quotations in a tabular format but another way to present the options is to use graphs or charts. Not only does this make it easier for clients to compare options, it demonstrates the advantages of taking a longer view of retirement.
Step 3: Decide which options most suitable
This is the point at which the decision about which annuity or drawdown policy, or a combination, will be arranged.
There are a number of ways to decide which annuity or drawdown options are most appropriate for an individual’s circumstances:
- The individual may have already reached their own conclusion based on the information presented
- They may have established a preference and are looking for confirmation that the right decision has been made
- lThe individual may be unsure about which option is most suitable and looking for a personal recommendation from a financial adviser
- No matter how decisions are made, it is important to be sure that the chosen options are suitable for the individual’s circumstances. In general terms the chosen options will be suitable if the solution meets all of the following criteria:
- Meets the known income requirements;
- If necessary, has sufficient flexibility to deal with any future change in circumstances;
- Provides the appropriate death benefits;
- Is in line with the individual’s risk profile and capacity for loss into account.
- In order to check the suitability of any decisions made, a simple check list can be used:
- If a guaranteed annuity
- Does the individual qualify for enhanced terms?
- f single life and the annuitant has a partner, has a joint life annuity been considered?
- Has the guarantee period and escalation option been discussed?
- lIf the individual has indicated need for flexibility or prepared to consider investment linking, has following been considered: investment-linked, fixed term, drawdown.
- If investment-linked or fixed term
- Does the client have sufficient secure income in the event that any future income falls in value?
- Does the client understand the associated risks and have capacity to take risk?
- Have all the other relevant options been considered and evaluated?
Investing in an annuity or pension drawdown plan will be one of the most important decisions that many individuals will make. If they make the right decisions they will achieve the best outcome for their circumstances but if they make the wrong decisions they may regret their decisions in the future.
Some of the questions raised in the decision making process probably rank as some of the most difficult in personal financial planning and therefore should not be taken lightly. Some questions, for example which company is paying the highest income are relatively easy to answer.
But some questions such as which type of annuity or drawdown is most suitable are much more complex.
In short, shopping around for the best annuity is getting easier, but as many individuals are retiring with more complex income requirements, the decision about which type of policy to go shopping for in the first place is becoming more complex.
It is not just the high-net-worth individuals who need to spend more time considering their annuity and drawdown options. There are many individuals with pension funds valued above the national average of £30,000 who also need to spend more time looking at the key issues especially in the post RDR world where many perceive advice as being complex and expensive.
Billy Burrows is director at The Retirement Academy
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