The Government has extended its relaxation of the annuity rules to those on the cusp of retirement. It announced that those who had taken their tax-free lump sum immediately prior to the budget will no longer have to buy an annuity within six months. This frees thousands more retirees from the obligation to buy an annuity, but there are important investment considerations for the retirees in this bracket.
The general rule has been that investors lower risk in their portfolios in the years running up to retirement. This has meant reducing equity and corporate bond exposure gradually, moving into UK government bonds, on which annuity prices are based. This minimises market risk at the point of retirement – investors phase their exit from higher risk, higher volatility markets and therefore minimise the chance of exiting at the wrong point in the market cycle.
No Need to De-risk
The removal of the obligation to buy an annuity should force investors to reconsider this shift. If they are not moving into a gilt-based product at retirement, there is no longer a need to de-risk in the same way. This is particularly pertinent at the moment, when gilts continue to look poor value as interest rate rises loom.
Hargreaves Lansdown has already highlighted the problem in connection with lifestyle pension funds, which are often used as the default scheme for defined contribution corporate pension schemes. These automatically shift into fixed income and, ultimately, gilts based on a pre-determined retirement age, assuming annuity purchase at the end of the term. Danny Cox, head of advice at the group, says: "Lifestyling will still suit those who buy an annuity. However, they will only be appropriate for those who are clear – years in advance – of the date they will do so."
Annuity May Still Have a Place
The problem for the latest group of retirees freed from the obligation to buy annuities is that they might already be part way through this process, whether via a lifestyle fund or in a personal pension portfolio. They will have de-risked into gilts over the past few years and now face complex options: should they move selectively back into the equity market? At best, this offers far less value than it did a year ago. Corporate bonds are sitting on the back of a decade-long bull run. The majority of lower risk income sources look expensive. It may be that for these investors, annuities should still be considered, at least for part of the portfolio, as the market risk elsewhere may be too great.
Freedom of Choice for Some
For those earlier in the process, there will be more freedom of investment choices. Skandia’s retirement planning manager, Adrian Walker, says that the new world of retirement income planning will alter significantly. As income from defined contribution pension savings of all types can be taken in a number of different ways, the increased flexibility will alter the investment strategies that retirees may need to consider.
He adds: "It is no longer a case of having distinct ‘accumulation’ and ‘decumulation’ phases. Short-term income needs can be met by simply phasing a taxed lump sum from the pension savings, of which 25% of the encashment will provide a tax-free element of income.
"The remainder of the client’s pension capital will remain untouched at that point, available for future use, Depending on the longer term income planning such a client requires, the investment strategy for the remaining fund could see some level of equity exposure remaining, as clients could be seen to still be in the accumulation phase of retirement planning."
Companies Introducing New Post-retirement Solutions
Companies have increasingly been devising new solutions that may offer one-stop solutions for the new post-retirement investment market, having long recognised an end to annuities may be on the horizon. Old Mutual Global Investors has its Generation range, which aims to manage the two key targets for retirees – income generation and inflation protection. Axa IM, Kames and Goldman Sachs have all launched new multi-asset income funds this year with similar objectives. Fidelity added new Balanced, and Income and Growth funds to its Multi-asset Income range at the end of last year.
Cedric Bucher, head of business development at Architas, said: “We see a range of income solutions developing, with various degrees of investment risk, capital protection or inflation protection. Investment solutions with an income focus will be more and more diversified, investing in multiple asset classes. On the one hand, multi asset investments diversify risk; on the other hand, they are able to flexibly source income from various asset classes, whether equities, fixed income or alternatives.”
The relaxation of the rules on annuities will allow many investors greater flexibility. However, those on the cusp of retirement may not be able to use this flexibility to the maximum because they have already started the process of de-risking in anticipation of an annuity purchase. For those further away from retirement, a broader range of solutions are emerging.
