For people not fortunate enough to be part of a final- salary pension scheme,there are really only twoways to take retirement income – an annuity or income drawdown.
Annuities are still the best option for retirement income for most people, due tothe certainty of income,but unsecured pensionsor income drawdown are gaining in popularity.
One of the big drivers of interest in income drawdown is the unpopularity of annuities.
The past few years have seen very low interest rates and, as this partly determines annuity rates, the annual income generated compared with the size of an individual’s pension has dropped dramatically compared with 10 years ago.
Figures from Moneyfacts show that although annuity rates improved significantly in 2007, they have dropped by around 30 per cent inthe past 10 years.
Consilium Financial Planning managing director Kevin Morgan says the lackof appeal is partially due to annuity rates but it is also due to the inflexibilityof annuities.
He says: “Psychologically,if you pay into a pension for 40 years and you take your tax-free cash and then the rest is turned into an annuity through the conversionrates, you are less than overwhelmed.”
AJS Wealth Management director Anna Sofat says people have a much greater expectations of the levelof income that theirpensions should provide.
She says: “Over the last20 years, more and more people have been encouraged to save, mainly into money-purchase arrangements so more and more people recognise the value of their savings.”
The unpopularity of annuities is not confined to pension savers as IFAsare also not impressed bythe poor value on offer.
A study by Prudential last year found that over half of advisers think conventional annuities do not provide enough value.
A number of providersare introducing income drawdown facilities. Pruden-tial included a drawdown option in its flexible retire-ment plan towards the endof last year and Scottish Life added an income drawdown option to its pension portfolio at the end of 2007.
Pru director of retirement income Aston Goodey says: “The retirement market is changing beyond all recognition, yet the solutions available to advisers and clients have not kept pacein terms of flexibility and transparency. Clients want simplicity of product and charges, and the ability to manage their retirement plans in one place. They want to maximise their incomein retirement.”
Another factor in the growth in popularity of income drawdown plansis the change in the rules governing the rates of income withdrawal that clients have to takein retirement.
Before A-Day, clients had to take some income from their fund in order to qualify for their tax-free cash but since then the minimum income requirement has been reduced to nil, opening the option of income drawdown to many more people. The minimum income requirement usedto mean that drawdown was only open to the wealthybut now anyone, regardless of the size of their pension pot, can take their TFC entitlement and leavethe remaining fund fully invested until they wantto buy an annuity.
Another of the A-Day changes means that income drawdown no longer hasto be postponed until retirement. Scottish Life’s income-release facility takes advantage of the fact thatyou now no longer haveto stop work to start taking your pension benefits.
Scottish Life head of individual business Keith MacPherson says by allowing the crystallisation of part ofa client’s pension benefits, they can take tax-free cash while still contributing to their pension.
He says: “Income release allows individuals to geta tax-free lump sum from their pension plan after the age of 50 while still building up their pension fund.It means that a pension isno longer locked up until you stop working.”
Sofat says the ability to move into retirement at an earlier age but still contribute to a pension isa big attraction for her clients. “The majority of my client base have opted for drawdown,” she says.
All this flexibility does cost money and, bearing in mind the size of a client’s pension fund, annuitieswill continue to be thebest option for many clients but drawdown offers growing flexibility for an increasing number of people.
Morgan says: “As an IFA, we can put together a hybrid income plan to suit our clients. There are all sorts of options available now. Clients should understand that it will cost a little more this way, but it is a choice they will have to make.”