QUESTION: I am approaching retirement and confused by the various options on offer. Can you explain what the main alternatives are?
ANSWER: A combination of low interest rates and increased life expectancy has meant
that the income levels for those who retire today is dramatically lower than those
enjoyed by people who retired a number of years ago.
These factors have led to the innovation in the retirement industry which now offers
people a greater range of choice as to how they secure an income from their pension
fund at retirement. In the past there were broadly two options available.
Firstly an individual could buy a fixed annuity which would provide a certain level
of income on a guaranteed basis. The alternative, usually the reserve of the wealthy,
was to go into what was known as an income drawdown.
Because of the wider range of options now available, this area of financial planning
is more complex than ever and as an annuity purchase is an irrevocable decision, any
errors made will be a costly and permanent mistake.
Despite all of this, the fact of the matter is that when most people get to retirement,
they purchase the annuity with the company they have built their pension fund up with.
There are two errors with this decision.
Firstly, the chance that the company you have used to date offers the best rate going
forward is very slim. Secondly, the chances that that company can offer you the best
range of options without discussion of your circumstances are also very slim.
If an annuity is an appropriate retirement income vehicle, then not only do you need
to consider the type of income you require and what proportion should be passed to
a spouse in the event of your death, but consideration should also be given as to
whether or not you can benefit from what are known as impaired life annuities.
The income received from these types can be enhanced on the basis of your health,
life expectancy or even postcode. The greatest enhancements are given to those who
have the shortest life expectancy due to an illness or lifestyle choice such as smoking.
The average enhancement from an impaired life annuity works out at around 20% and
in some instances can be as high as 40%.
If a fixed income is not required then an Unsecured Pension (USP) may be appropriate.
Under this type of arrangement the pension fund built up remains under your control
and the deferment of an annuity can be left until age 75.
At any time you can decide to take an annuity or continue to an Alternatively Secured
Pension (ASP) at 75.
The income that can be withdrawn from USP is flexible and works out slightly higher
than that available from a conventional annuity. However these types of arrangement
do not provide a guaranteed level of income, and therefore carry a higher degree of risk.
Some alternative products were introduced last year that in effect are a hybrid between
an annuity and USP. These have caused quite a stir in the market and are known as
third way products.
They will, in certain circumstances, offer an unsecured pension with some guarantees.
These arrangements are available from various providers but differ with regards to
costs, income withdrawals and investment options.
So as you can see, your options at retirement are considerable and the most suitable
arrangement will be driven by your current circumstances and future needs.
It is vital therefore that you take the time to consider the options with a well versed,
qualified adviser who can help you through the maze that presents itself at retirement.
Raymond Mulligan is managing director of Johnston Campbell, a company of independent
financial advisers regulated by the Financial Services Authority. For further from
email@example.com or 02890-221010.