Ready to retire? In the past, unless you could prove considerable income in retirement, you would have to buy an annuity with your accumulated pension savings. An annuity guarantees a steady income stream in retirement – either the same annual income every year, or if it is index-linked a growing income to combat inflation.
The trouble with annuities is they are linked to gilt rates, meaning that what your pension pot bought you a decade ago is considerably different to what that same amount of cash would buy you today. Many people also failed to exercise their open-market option, instead buying the first annuity they were offered by their pension savings scheme provider – and shopping around could boost your retirement income by up to a third.
The deadline nature of an annuity purchase has also proved problematic. Pension schemes build up their value through investment in the stock market, meaning the lump sum you have to purchase an annuity is sensitive to stock market fluctuations. Those retiring in 2006 for example, before the FTSE 100 lost considerable value, would have had a significantly larger pot with which to buy an annuity than those retiring in 2008.
The new ‘pensions freedom’ announced by George Osborne in March’s Budget scrapping compulsory annuity purchasing, eradicates many of these issues. If you retire during a blip in stock market performance, you can choose to stay invested and take cash a later date, once equities have – hopefully – rebounded. Your income will be dependent on when and how you choose to drawdown your cash – on retirement, five years later, or even 20 years later.
But annuities still have a place in the post-Budget retirement landscape. They appeal to those who want the stability of a steady, guaranteed income in retirement, and annuity providers predict they will still serve around 30% of the retired population once Osborne’s policies have come into action.
But retirement specialists MGM Advantage have warned those who do wish to purchase an annuity not to delay the purchase until next tax year.
Using the example of a 65-year-old with a pension fund of £50,000, and their figures suggest it would take 40 years to recoup the ‘missed’ income by delaying annuity purchase by two years.
Andrew Tully, director at MGM Advantage said: ‘These figures demonstrate that there are scenarios where it might be worthwhile delaying making a decision until after April 2015. But if people want some level of sustainable income, they need to be aware that they are taking a big gamble that a number of things work in their favour.
“As the numbers show if everything remains unchanged it would take 40 years to recoup the missed income. That’s a lot longer than the average person expects to live at age 65.”
In the current low-interest rate environment, Tom McPhail of Hargreaves Lansdown agrees delay could cost pensioners thousands of pounds.
“There are undoubtedly some investors who listened to advice to defer over the past few years in the hope that rates would rise, who have missed out on thousands of pounds of income as a result,” he said.
“If you are going to put off buying an annuity, it should only be as part of a structured investment strategy, for example using drawdown as you'd need to be generating a return of several per cent a year to offset the lost income.”
