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A botched pot never boils

I am approaching retirement at age 60 with substantial amounts in pension funds accumulated over the last 25 years.

Only a few years ago, it seemed an adequate income would be available from conventional annuities but I have read alarming stories of falling returns and the risks associated with alternatives such as unit-linked and drawdown annuities. What should I do to support myself in retirement?

The background to your predicament is worth examining to understand the options that are available to you in the future. Over the last 10 years, interest rates have progressively fallen as inflation has been brought under control.

In particular, the return from long-dated Government securities has fallen dramatically. As annuity rates have historically been obtained by locking into these returns, the result has been a corresponding fall in annuity incomes.

The problem is that this only shows part of the story. Although incomes looked more impressive 10 years ago, this hid an unpalatable truth. Most people were not making sufficient provision for retirement to afford to purchase escalating pensions. Even where this was possible, the rate of escalation was insufficient to combat the rate at which the purchasing power deteriorated. Because inflation is felt, rather than seen, it does not make the same impact in the media when incomes are discussed.

Now that inflation is under greater control, annuity returns have reflected this fact and the underprovision for pension income has become glaringly apparent. It is not that annuities are offering less value for money, as many commentators have suggested, it is that the previous returns were, in the long run, equally inadequate.

Illustrations hid the fact that the anticipated income would not have matched the loss of purchasing power had inflation continued at such high levels.

It was a peculiar anomaly of investment planning that the industry encouraged the use of equities to provide the dynamic returns over the accumulation period on the basis that long-term returns would be better than fixed interest. When retirement age was reached and an individual faced perhaps 20 or 25 years living off the accumulated fund, they were then switched immediately into a 100 per cent gilt-based investment strategy. This was patently foolish.

The tendency towards early retirement and the improvement in longevity has only made matters worse because funds must last much longer.

What can you do? Assuming delaying your retirement is not an option, you should adopt exactly the same approach to your pension funds as you would with any other pot of money. The strategy is no different.

Since the shortfall discussed above has become apparent to the providers of retirement income, many more ways of delivering the income have been devised. It is now possible, with the aid of professional advice, to build a portfolio of income-producing arrangements, via the segments of the various retirement contracts you own, which will help you over the years to come.

First, you should assess the level of your fixed expenses before you start to consider your other outgoings. You are more fortunate than most to have sufficient funds to be able to segregate them in this way. To cover these fixed expenses, a traditional annuity is ideal.

For the balance, you can use all the range of available solutions. Income drawdown is useful to preserve the capital for dependants and to delay the point at which you must decide the type of annuity to be taken. For example, as a married man, you will not wish to purchase a single-life annuity but you will want to delay the decision as long as possible.

The availability of self-invested annuity funds will allow you the best of both worlds for that segment of capital which you are prepared to forgo in the event of your death, before your actuarial life expectancy has expired. These enable you to continue to control your own investment strategy but benefit from the mortality bonus that comes from participating from a pool of annuitants&#39 capital.

In other words, those that die early contribute to your retirement income by increasing the return. Another advantage is that the level of return is not governed by the Government actuary&#39s view, which is still limited by the return on fixed-interest securities.

If the self-invested option does not appeal to you, there are unit-linked and with-profits alternatives available from various providers, with more entering the market at regular intervals as they realise the potential.

No one can solve the problem of an inadequate retirement fund but at least there are more weapons available to use in the battle. Inflation is not dead. It may just be resting, waiting for another opportunity to make a comeback.


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