This is a difficult time for those wanting an income from their pension pot. Turbulent markets, gilt yields at a historic low, falling annuity rates, high inflation and reductions in the maximum drawdown income all make it an extremely complex and volatile time to be making crucial long-term decisions. But choices need to be made as most people still need a retirement income as they reduce their working hours or retire completely.
The income we can get from lifetime annuities has plummeted and locking into a low annuity rate has another potential downside as inflation is likely to have a significant impact on future income. It is crucial that those buying a lifetime annuity make sure they get the best possible rate and shopping around and ensuring all medical and lifestyle conditions are high-lighted is key.
The traditional alternative of drawdown is also facing more than its fair share of challenges. The Government’s decision to reduce the maximum income to 100 per cent of the equivalent annuity was based on the long-term view that people should not strip out excessive income after age 75, run out of money and fall back on the state. But it has come at an inopportune time, with gilt yields falling from above 4 per cent a year ago to around 2.5 per cent now. This translates to around a 20 per cent drop in income for a 65-year-old male. Add in the general decline in fund values and that explains the 40 per cent or 50 per cent income reductions being seen by some of those reaching drawdown reviews.
Fortunately, we now have other options in the retirement market. Variable annuities guarantee a minimum level of income through the use of derivatives although they can be expensive. Fixed-term annuities are becoming increasing popular as a way of deferring the purchase of a lifetime annuity in the hope that rates will increase or personal circumstances change, allowing a higher income in future.
Investment-linked annuities are another option and the Government has confirmed the 120 per cent maximum income available from these contracts will continue. That is because, unlike drawdown, customers cannot run out of money.
There is a minimum income guarantee and, as annuities, people benefit from mortality cross-subsidy which allows a higher income to be with-drawn without increasing the risk of depleting funds.
These newer options give alternative choices to the traditional routes and will be valuable to many clients. More will benefit from using a combination of solutions as they go through the various phases of retirement. Whoever you are advising, it is worth making the most of the new range of solutions out there.
Andrew Tully is pensions technical director at MGM Advantage