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Family fortunes

Retirement income is an issue that crosses the generations.

I am hearing lots about new pension options and want to start saving into a pension. Also, my parents are about to retire and I want to ensure that they are aware of their retirement income options.

First, let me talk to you about your pension position. Almost a quarter of UK workers are not saving at all for their retirement and one in three people actively saving do not know what their main source of income will be in retirement.

To remedy this situation, the Government is trying to automatically enrol employees into a new pension system called personal accounts. From 2012, workers who are not in occupational pension schemes will be automatically enrolled in personal accounts unless they specifically opt out.

Staff will pay in 4 per cent of their salaries and employers 3 per cent, with an extra 1 per cent from the Government in tax relief.

However, according to the Scottish Widows pensions index, only a third of those without a current pension intend to remain in personal accounts when they are introduced in five years.

You cannot afford to wait for personal accounts to be introduced as a five-year delay in starting pension savings could be very damaging to your later fund value. I therefore advise you to join your workplace group personal pension now and I will advise you separately about your fund options.

As for your parents, the choices on how they can take their accumulated pension fund were very restrictive until recently.

It is estimated that only around 40 per cent of people shop around when taking an annuity to secure their retirement income. Make sure your parents use the open-market option to secure the most suitable income, particularly as annuity rates are historically low.

Greater flexibility is now offered by unsecured pensions as an alternative to buying a traditional annuity. These will allow your parents to draw an income from their pension fund while leaving the fund invested. As they are both under 75, they can take out an unsecured pension and either draw an income by using income withdrawal or pension drawdown or use limited period annuities. These allow your parents to buy annuities in smaller chunks, each spanning a five-year term, while the rest of their fund can be left invested. This will give them more choice on when to buy annuities and also allows them to maintain more control over their pension fund.

As an IFA, I will, of course, look at the whole market to ensure your parents are buying the most suitable annuity in every five-year period. Unsecured pensions can be used up to 75 and policyholders can take up to 120 per cent of the annual income payable from a single-life level annuity. There is no minimum amount.

Also available are value-protected annuities which are a response to one of the key criticisms of traditional annuities – that if your parents die soon after buying annuities, you and the rest of the family will lose out on the value of your parents’ pension funds built up over their lifetimes as the money is retained by the insurance company providing the annuity.

With value-protected annuities, if the pension fund used to buy the annuity has not been totally paid out to the annuitant and they die before 75, the balance will be paid to the policyholder’s estate after a tax charge of 35 per cent has been deducted.

Do be aware that the cost for this value guarantee will be reflected in the rates for value-protected annuities, which could be notably lower than on traditional annuities.

Under the new pension rules, once your parents reach 75, they will still have to buy an annuity, if they have not done so already, although there is now an option called an alternatively secured pension which may be attractive to some people, particularly those who have a principled religious objection to annuitisation.

Be aware that if you choose a flexible annuity or what are being called third-way retirement products, you are bringing an element of risk to the value of your retirement income. Alternatively, if you want a guarantee that the value will not drop, there will be a cost that will erode the fund value.

You need to tell your parents to seek independent financial advice as an IFA is the only type of UK financial adviser that can advise on every aspect of every pension funding and annuity option available from the whole market.

Kim North is founder of Technology & Technical.

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