13th May 2014
For the four hundred thousand or so people reaching retirement each year the current debate about what to do with your new-found pension freedom is more than just theoretical – it’s time for that pension to start paying out hard cash. But with so much still in the air, what should wannabee retirees actually do asks pension journalist John Greenwood.
Before the Budget in March, life was simple. Most of us bought annuities and moaned about what poor value they are. Now Chancellor George Osborne has promised everyone free access to their cash, its hard not to feel a nagging concern that any option you go for might, with hindsight, turn out to have been a bad one.
A year from now you might even find yourself wishing you had gone for an annuity after all. In fact a report out this week from the independent Pensions Policy Institute highlighted the many countries around the world where annuities are the product of choice for the majority. Take Switzerland, for example, where 80 per cent of people buy annuities even though they are free to take their cash, as do 85 per cent of Danes and 70 per cent of those in Chile. The report also highlights efforts by authorities in the US and Australia to increase annuity take-up from its low level.
What is certain is that we will see creative new retirement options come to the market in the next year or two. But like the rest of us, providers have only known what the new rules are for a few weeks, so it is fair to say they are yet to invent their best possible products. So the idea of a wait-and-see option feels like a good one.
The first new products off the blocks aim to meet this desire for a stopgap. Several providers have launched one-year fixed term annuities, several of which have come in for heavy criticism. With these products the insurance company takes your money, gives you some of it back straight away as ‘income’, and then give you the rest of it back a year later, plus 0.5 per cent interest but often minus 2 per cent sales commission, meaning you can end up with less than you started with.
If you need income now you could simply draw out some of your 25 per cent tax-free cash lump sum. Depending on your age and health condition, and the type of inflation protection you want, an annuity could be paying out perhaps 5 per cent. But you can replicate the income an annuity would pay by simply drawing 5 per cent from your pension and leaving the rest invested.
To do this you need to go into income drawdown. The majority of modern pensions – those taken out in the last six to 10 years – will allow you to go into drawdown for no extra charge, although you will still have to pay the pension’s annual management charge. Older pension plans may not allow you to go into drawdown so speak to your adviser or pension provider about the options.
If you do go into drawdown you will have to decide what you want to do with your pension’s investments. If it is complete security you are after, then you should select the pension scheme’s cash fund, although this will only pay a return somewhere around Bank of England base rate, which will probably be wiped out by your charges. Or you could opt for bonds or equities, which could give you a higher return, although there is a risk your fund could fall. It’s not easy.
It’s worth mentioning that if you are approaching state pension age, there is one no-brainer option – deferring your state pension and living off your tax-free cash. For every year you delay drawing your state pension, your income is increased by 10.4 per cent, inflation-proofed for life – by far the best deal on the annuity market.
There are lots of reasons you might want to put off making a decision about what to do with your pot –after all, it’s only six weeks since Mr Osborne turned the pensions world on its head. Who knows? You might even decide to join the Swiss, Danes and Chileans and fall back in love with annuities.