What is your pension for, anyway?
Ask most people what they think a pension is for and they will probably answer “retirement”. Go in with a follow-up question and you might prompt them to say that it is “to provide an income in retirement”. Put like this, it sounds quite clear-cut. Using a single word like retirement to describe a period in a person’s life gives the comforting impression that it has some sort of known parameters. However, unlike other periods in our lives – such as childhood, schooldays, working-life or parenthood – we have no way of knowing when this one ends.
Some big changes over the years
In the olden days, a pension was exactly as described: an income in retirement. Paid by the company or public sector body that you or your spouse had worked for during your working life, this was regular money coming in every month and guaranteed until you died. A couple of things have changed since this was the norm – largely because of just how expensive and difficult to manage such a commitment was for the company or organisation involved. Over the decades, companies in particular have been drawing back from this type of arrangement, favouring instead one that builds up funds in a pot of money for each employee. This pot is then presented to the employee on retirement with a number of options. And this brings us to the second big change that has happened – these options expanded in 2015 granting retirees much more freedom in how they can manage this pot of money over the rest of their life.
Low interest rates? Not very attractive
It is important to note that, at the time this new freedom and flexibility came in, we were in a world where interest rates were unusually low. One of the retirement options has always been to convert your pot of money to the type of guaranteed income that was associated with the old-style company pensions – this is what an annuity is. However, when interest rates are low, the amount of income you can get for every pound in your pot is not very attractive. And once you’ve made the choice to buy an annuity, that money from your pot is gone and the rate is locked in forever (other than perhaps a link to inflation, depending on what you choose at the time).
Flexibility to suit your changing lifestyle
So, over the years, many people have chosen instead to keep most of the pot invested. This has given it the potential to grow and allows them to take their income flexibly – perhaps taking more in the early, younger years of retirement and less when the desire to go globe-trotting has abated. This arrangement also means you can adjust the income you take from the pot when your state pension and/or inheritance kicks in, which means that sometimes there is money left in the invested pot to pass onto children or grandchildren.
Money worries
All of which sounds great, but what it doesn’t allow for is the possibility that you live longer than expected and your pot runs dry while you are still very much alive and kicking. According to research published last month by the Financial Services Compensation Scheme Attitudes towards the retirement of tomorrow, “82% of respondents can identify at least one concern about saving for their retirement. The main worry is not having enough money to last the duration of their retirement”.
Annuities back in the spotlight
And that brings us up to the current day where we have a whole new interest-rate scenario. Rates are now at a 15-year high and the Bank of England has indicated at its November meeting that we should not expect them to come down any time soon. What this means is that anyone considering using some or all of their pension pot to buy an annuity can expect to lock in a higher level of annual income for the rest of their lives than they would have been able to one or two years ago. This puts old-style, guaranteed income payments in retirement – aka annuities – back in the spotlight.
Covering your basics
All of which means that annuities could now be in the running for a leading role in your retirement – one where the script is to make sure that your ‘basic needs’ are covered. Things like utility bills, food and other essentials will all need to be paid for whether you are spending your well-earned time in the pasture tidying your sock drawer or flitting from one (over) eighties rave to the next. Everyone will have different pension amounts and so can approach this individually. But, as a rule of thumb, aiming to cover off your essential monthly spending needs with income that is guaranteed for the rest of your life – regardless of how long that might be – is a good starting point.
You don’t have to use it all
Of course, any state pension that you are entitled to also counts as guaranteed income so it might be that you don’t need to use all of the pension pot to get the amount you need for your basics. If there is any surplus in the pot, you can either choose to ‘buy’ more income or use it flexibly, depending on what your goals are. And it’s worth emphasising that, if you are already retired and have chosen to take your pension flexibly, buying an annuity is probably an option that remains on the table. Remember, you don’t have to use all of your fund – just enough to buy an income that will stop you worrying about how much life is left when the bottom of the pension pot heaves in sight.
Happy to talk
As with all things financial there are a number of specifics that need to be considered before taking a decision like this. Making sure that surviving loved-ones and dependants are secure after you die is one such consideration and, in addition, there may be tax implications depending on your circumstances. Annuities also come in different shapes and sizes (such as inflation-proofing and potential benefits after death) and each option needs to be assessed against your needs. However, the fact remains that annuities are looking more attractive than they used to and this is something that is worth bearing in mind for anyone in or close to retirement. A Financial Planner is well placed to help you weigh up the pros and cons of annuities in all their guises and – as ever at Talking Finances – we are happy to talk.
Carole Haswell DipPFS
Financial Planner at Talking Finances
Talking Finances is a trading name of Talking Finances Ltd. Talking Finances Ltd is an appointed representative of Parallel Lines The Advisor Collective Ltd, No.2 Sopwith Court, Slough Road, Datchet, Berks SL3 9AU, which is authorised and regulated by the Financial Conduct Authority. FCA Registration No. 967228
This article represents the personal opinion of Carole Haswell only and does not represent any opinion of Parallel Lines the Advisor Collective Ltd. Financial decisions should not be made on the basis of this article.
- All content is based on my understanding of current legislation, which is subject to change.
- This blog is for general information only and does not constitute advice.
