Value for money?

September 3rd, 2009

If  you are reaching the time of life when retirement decisions need to be made, it is important that careful consideration is given to those decisions because a substantial part of your income will no longer be paid by your employer, or business, and this will need to be replaced by the pensions and investments you have built up throughout your working life.  Often though, even with planning and after including state benefits, the funds you have available to provide you with an income in retirement may be insufficient to provide you with the amount you would like, thus increasing the importance of these decisions still further.

Your income in retirement can come from a number of sources:

  • Savings (such as deposits in a bank or building society )
  • Investments
  • Individual Savings Account
  • Investment Bond
  • Shares
  • Unit Trusts
  • National Savings Plan
  • Endowment
  • Pensions
  • Annuity
  • Occupational pension
  • State pension
  • Additional state pensions
  • Inherited pension
  • Equity release (either lump sum or regular drawdown)
  • Purchased life annuity

The key issues to address are not only how you will replace your ‘lost’ income once you have retired, but how you will ensure that this income can be provided for the long term. For example, even if the income is guaranteed, will it keep pace with the cost of living?

Due to the complexity of the decisions that need to be made, this article will consider only one area this time – that of what to do with a pension fund if you are considering buying an annuity. This is not the only option and advice should be sought to understand what best suits your needs, but it is currently the most selected option at retirement for a pension fund.

A key reason for annuities being so popular is a lack of knowledge and understanding as to what you can do with your pension funds – and the fact that annuities have traditionally been the only option.

What is an annuity?

An annuity is the promise to pay a specific income (either on a monthly, quarterly, or annual basis) for either a specified period, or for life, in exchange for a lump sum of money.

The annuity rate (how much income is promised per £1,000) will vary based on your age, health, sex, the protection options selected, and whether it will be an income that increases or remains level in payment. An example of how this can vary is illustrated below:

Income provided by a £10,000 fund based on a healthy, non-smoking, 65 year old male (with a spouse the same age) for various options (based on the FSA Comparative Tables on 23/07/2009)

Level Pension for Life (no increases)

  • Single life, no guarantees                        £660.00 pa
  • 50% Spouse pension on death, no other guarantees             £600.00 pa

Pension escalating at 3% per annum

  • Single life, no guarantees                        £468.00 pa
  • 50% Spouse pension on death, no other guarantees        £420.00 pa

At first glance, the level pension could appear to offer the best value given that it pays the higher initial amount, but the annual income received from the escalating pension will overtake the annual income received from the level pension by age 77 and the total amount of income received (i.e. the total payments accumulated) will be greater under the escalating pension by age 87.  This may seem a long way off for someone who is 65 now, but longevity is ever increasing, and more people now than ever before can expect to live beyond 100. It should also be considered that this income may be required to help fund care costs in the later years.

The issue of inflation is also important to consider of course.  This is because inflation will inevitably erode the value of a pension that does not increase in payment, so, unless adequate planning elsewhere is put in place, you could have income shortages in years’ to come.

Finally, it is important to remember that enhanced incomes may be obtained if you are a smoker, have a certain medical condition such as diabetes or high blood pressure, or live in an area where enhanced post code annuities are available.
Furthermore, if you  are medically certified as having less than 5 years to live, you could qualify for an ‘impaired life’ annuity and if you are unfortunate enough to be medically certified as having less than 12 months to live, you may be able to take the whole of your pension fund as a tax-free lump sum.

It is therefore essential to look at what is on offer and consider your options carefully, rather than just rely on what is sent to you in the post by your pension provider.

With careful planning, a more sustainable lifestyle can be achieved until very late in life.

The levels and bases of and reliefs from taxation are subject to change and their value depends on the individual circumstances of the investor.

  • Savings (such as deposits in a bank or building society )