Before we get into “pension freedoms”, how did they come about? Well basically, the decline in pension contributions over the last few decades has in many ways been caused by the decline in annuity rates and their perceived poor value.
However, annuities have one great benefit. They offer simple solution in a volatile world. You make decision to purchase and annuity and in return for which you get a guaranteed income for life.
Unfortunately, the income may not be what you’d like it would be. As a consequence of that, the government introduced pensions freedoms, which allows people to keep their pension funds invested and draw an income from them instead of having to buy the dreaded annuity. “Sounds great”, I hear you say. But is it really as good as it looks.
Just because you can, does not mean that it is a good idea for everyone
If it there to spend, then many people will. So, with pension freedoms comes responsibility and the need for understanding and control. Otherwise there is the very real possibility that many people will accidentally run out of money before they run out of life. Rather like running out of income, before the next pay day.
So, it’s going to be very important to ensure that a pension pot lasts a lifetime or other income kicks in. We are moving from a situation where the annuity provider had to make sure that funds could be paid until the end of a person’s life, to a situation where the individual has to ensure that they do not overspend or even lice too long.
In my opinion, having some form of guaranteed income is going to prove to be very important for many people.
If your income is entirely dependent on working out how much income you can afford to take and the performance of your investments, getting it right is going to be very important. You just are not going to be able to afford to get this wrong. For some retirees, they may have alternative incomes, such as buy-to-let income or defined benefit pension income, which will help offset the risk, but for others the potential rewards on offer thanks to pensions freedoms has to be weighed up very carefully against the potential risks.
So, what is the answer?
· Don’t ignore annuities
For all the bad press that annuities have, they should not be overlooked. Despite annuity rates being on a long-term decline, the offer a guaranteed income for life with no investment risk. Compared to deposit returns, the rates offered by annuity companies offer quite favourably.
· Guaranteed payment periods
If an annuity is going to make up part of your retirement income, the inclusion of a guaranteed payment period is very important to consider. Even if you were to die prematurely the income can continue to be paid to either your spouse or into your state. Guaranteed payment periods can now be for up to 30 years. Well worth considering.
· Sustainable income withdrawal rate
Inevitably many people will choose the “pension freedom” option. For this to work out in the long term and to not run out of money, taking cautious income withdrawals is going to be essential. Sustainable income withdrawals of around 3% will give you a better chance of not running out of money during your lifetime.
· Defer pension income/spend pensions last
At one time, when people reached retirement age they automatically started to take their pension benefits, as most people took their tax-free cash and purchased an annuity with the balance. Not so the case any longer. Because pension death benefits are now more favourable than ever, in that the residue can pass onto the next generation, leaving your pension fund to draw on later or last of makes a lot of sense. Under current pension legislation, the residue left in a pension fund is not liable to Inheritance Tax.
The new “pension freedom” rules have undoubtedly made pensions more attractive to many people, however caution needs to be exercised if people on not going to run out of money and find that they have to return to work in their mid-seventies or even older.
To make sure you don’t make a big mistake when starting to draw an income from your pension, my opinion is that it is essential to take advice from a professional financial adviser. If you get your calculation wrong the consequences are potentially enormous.
Contact Martin Dodd on 01902 742221 or email him at martin.dodd@miadvice.co.uk if you would like talk about money issues.
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The contents of this article should not be regarded as specific advice. No responsibility can be accepted by Martin Dodd or Midlands Investment Agency Ltd., for any loss that may occur by a person acting or refraining from acting on the basis of this article.
