The Third Way?
For several years, two main methods of producing income at retirement have been available to retirees, who have built up their own pension pots during their working life. These have been:
- The purchase of an annuity
- Income drawdown
With stock market volatility affecting many pension funds adversely and declining annuity rates compounding the problem faced by retirees at present, it is more important now than ever to ensure that all the options available at retirement are explored thoroughly and that the most appropriate way of securing pension income is selected for each individual person.
Lifetime annuities remain the most popular choice for most people, as they offer a fixed and guaranteed income for life and carry no investment risk. The drawbacks to this type of contract are that they contain no flexibility and cannot be changed once they have started. This means that decisions like the inclusion of spouses benefits and the need for increasing income, to help keep pace with inflation must be made at the outset as they cannot be added in later on.
Income drawdown on the other hand, enables individuals to draw income directly from their pension fund, which remains invested. This can, of course, lead to further fund growth but during times of poor performance can also lead to reductions in the value of the pension fund, which can in turn lead to reduced income. As investment risk applies to this type of plan, many people feel that it does not suit their requirements as most want to have at least some level of guarantee in relation to their income level, which drawdown simply does not offer. In addition, charges apply to this type of plan as there is a need for ongoing management of the underlying investments. These factors tend to make income drawdown the province of retirees with larger pension funds.
As these have been the two main options in the past, it is no surprise that lifetime annuities remain the choice of the vast majority of retirees but the insurance industry does recognise their limitations and are beginning to understand that people require a little more flexibility during their retirement, to accommodate changing income needs and, in some cases, to allow the opportunity to revisit the market place at a later stage.
In light of this, there are an increasing number of ‘third way’ retirement products entering the marketplace, which incorporate a range of investment backed annuities and fixed term annuities.
All of these products offer minimum guarantees regarding the level of income payable and also provide the opportunity to benefit from underlying investment growth. Some of them also provide the chance to defer decisions about spouses benefits until a later date, which can provide the opportunity for higher income today than a conventional annuity would offer.
The retirement market is developing quickly, as providers launch new products within the ‘third way’ category and this can only be good news for retirees as it broadens their options at retirement. Now more than ever it is vital to explore these options in detail and to take professional advice before making a final decision on how to provide a pension income that will suit you, both now and in the future.