As you know, I was thinking of retiring next year, when my predominantly with-profits personal pensions should have values approaching £250,000. We have discussed and discounted using income drawdown and decided to buy annuities. But I am concerned about recent events and would like your reassurance that all is going well for my retirement.
You are right to be concerned. Three critical events have happened this year that we will have to take into account before deciding whether immediate action is required.
The one that gives me the greatest concern is the knock-on effect from the Equitable Life debacle. Equitable's problems have highlighted the insecurity surrounding what was previously regarded as a secure investment, namely, with-profits funds. This insecurity is manifesting itself because of the second critical event, which is the continual decline in investment markets.
It is not just Equitable that is applying penalties for withdrawing funds early. Most leading companies have now introduced market value reductions. However, a more sinister problem may be looming and that is a significant reduction in future bonus declarations, particularly terminal bonuses. This is likely to be brought about by the ever continuing trend of lower inflation, interest rates and, therefore, more expensive annuity rates.
Unfortunately, we will not know until next year whether the decisions we take now will be the correct ones.
The dilemma is relatively straightforward. At retirement, you will have a known value for your pension fund. With that known value, we will be able to use the open-market option and purchase your pension from the company that is offering the best rates. This will give you the security and comfort of a known income for the rest of your own and your wife's life. You will know exactly where you stand.
However, the proceeding three problems could all conspire to shatter your dreams. Traditionally, it has always made sense to leave with-profits funds until normal retirement date, relying on an ever increasing terminal bonus. If we withdraw today, you could well encounter a market value reduction. If, however, we leave your funds to normal retirement date, are we going to see a dramatically reduced terminal bonus next year, meaning that the total value of your with-profits funds could actually be less next year than a reduced figure today?
The old general perception that this could not happen is wrong. Terminal bonuses are one-off payments and are at the whim of the institution. Equitable Life has shown us how such figures are in no way guaranteed and can fall. Everyone has seen a dramatic fall in investment returns over the last 12 months. There is a significant risk that the value of your with-profits funds next year could be less than a penalised value today.
Much has been written about ever decreasing annuity rates. With the recent 0.5 per cent cut in bank base rates, annuity rates across the board have fallen by around 4 per cent. Again, the convention that you should leave retirement until the last possible date and, therefore, attract better annuity rates, must be called into question.
Under static conditions, a five-year wait would only increase an annuity rate by around 9 per cent. Yet, at a stroke, 4 per cent has been written off the value of annuity rates in a day. If interest rates continue downwards, then you could find yourself in a position of not only having a lower fund at normal retirement but having to accept an annuity rate that is even lower than today.
We must look now at what your pension funds will provide for you and consider the risks of delaying buying your pension, when combined with all your other income-generating investments.
Normally, we would suggest that you leave your funds intact until next year, when their value will be greater. You will be a year older and we will be able to get a better annuity rate.
But we have to take a view related to investment conditions and interest rates factoring in the very many complicated issues that could conspire to reduce your income significantly. My general view is that, for anyone retiring in the near future, we should take action immediately rather than delay any longer.
I offer one final thought. Discounting income drawdown, there is nothing stopping us from hedging our bets and perhaps taking benefits from one policy – hopefully the one with the lowest MVR – and using that to buy an annuity today, leaving your other policies until normal retirement.