Retirees’’ dilemma

Retirees’’ dilemma

People retiring in the present economic climate face a dilemma, whether to secure their pension income now, despite very poor annuity rates, or to delay until rates might improve and meanwhile try to get by on other sources of income.

The evidence suggests that delaying may not be the best course. It is possible that rates might improve in the next year or two, but the full benefit of any increase may not be passed on to investors because annuity providers are having to accommodate ever-rising levels of life expectancy and the fragility of the bond market in which annuity funds are invested.

In addition, delaying means missing out on immediate income payments, which may not be recouped even if annuity rates do rise. Those who delay are often disappointed. A bird in the hand! When buying an annuity, the most important message is to shop around, not only between annuity providers but also between different types of annuity. The value of the income from a level annuity will quickly erode with inflation so, if a lengthy retirement period is anticipated, it may be wise to include provision for annual increases, or to opt for an annuity whose value is linked to share values, though this will depress the value of the immediate payments.

The most significant development in the annuity market in recent years has been the rise in popularity of annuities which reflect the state of individual investors’ health. These “enhanced” annuities can offer markedly improved levels of income. If there is a need to supplement pension income, the first port of call should be ISAs, the income from which is tax free and in this respect equity income funds currently offer significantly higher yields than most corporate bond funds and certainly much more attractive rates than cash deposits. Some fixed term structured products, whose returns depend on the level of stock markets at a future date, are also attractive, though great attention needs to be paid to the small print. At times like these, the return of capital is more important than the return on capital.

Those with larger pension funds are better placed to play a waiting game and may well prefer to keep their pension plans in place and draw an income from the investments under an income drawdown arrangement. Some suggest that it is worth considering drawdown for any pension pot over £150,000 in value, if this is to be the sole source of non-state pension income, but others suggest a rather higher figure.

Retirees who can demonstrate that their guaranteed pension income from sources other than their drawdown plan exceeds £20,000 a year are particularly well placed, because there is no limit on the amount they can withdraw.

The Government considers that having this level of income removes the risk of the investor having to turn to the state for support if the investments in their drawdown fund become worthless. For other drawdown investors; however, withdrawal levels are restricted by the Government and have recently been reduced, causing retirees to look to other potential sources of income.

Some may consider dipping into capital to supplement their income, but this should be a last resort, as also should the equity release schemes which enable householders to cash in on the value of their homes. Maintaining a capital buffer as protection against unforeseen future financial demands should always be a long term financial objective.

by Graham Thomas

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