Recently, we have seen an element of control given back to private pension fund holders and more flexibility in how they invest and receive their money in retirement. Many people perceive these long-term choices as fairly stark; they either move into drawdown, with an element of risk or acquire an annuity to provide an income for the rest of their lives. However, now we have what is known as “third way” pension products, which offer a hybrid between the two primary options.
Growing popularity of pension drawdown
Since the legal obligation to acquire an annuity was removed from the pension industry, there has been much focus on drawdown. This involves an element of income and long-term investment. The idea is simple; withdrawing sufficient funds to live while benefiting from long-term capital growth and dividend income on remaining assets.
Recent market volatility has shown the potential risks of moving into drawdown while additional pension fund capital remains invested. We have seen many of those in retirement forced to reduce or even cancel their drawdown plans, with a growing number returning to the workplace to secure a regular income.
Annuities are still an option
The recent rise in interest rates has also led to a significant increase in annuity rates, making them once again a viable option for many people entering retirement. There are numerous variations when it comes to annuities, but on the downside, capital growth is limited, and income is fixed (although some annuity incomes may move in line with inflation). On the plus side, income is traditionally guaranteed for the rest of your life, with some policies allowing part payment for beneficiaries on your death.
For those who are prepared to take on an element of risk, committing all or even part of their funds to an annuity may not offer the best long-term returns. Historically, in the longer term, stock markets have outperformed interest rates, inflation and the vast majority of other financial indicators. So what are the options?
Third way pension products
Often referred to as fixed-term income plans, a third way pension product is a hybrid between an annuity and drawdown. Some would say it offers the best of both worlds, but this depends on your attitude to risk and investment strategy. Depending on the type of product you choose, there is a degree of flexibility, but the main focus is that they are fixed-term income plans.
Predominately, there are two types of fixed-term income plans which are becoming more commonplace with private pension fund holders:-
Maximise income with no maturity value
If you had £100,000 available in your pension fund, you could look towards a third way product which would provide a fixed annual income, for a fixed period, with no maturity value. This may cover a gap between retirement and receipt of a state pension, or you may have other investments coming to fruition further down the line. An example of this would be as follows:-
Income plan purchase price: £100,000
Duration: 10 years
Annual income: £13,000
Guaranteed income: £130,000
Guaranteed maturity value: Zero
Income plus maturity value: £130,000
This is similar to an annuity, in that it has a guaranteed income, but this is only fixed for 10 years. If you have additional funds in your pension fund, there is always the option of taking out a further fixed-income plan on expiry, which may be beneficial if annuity rates have increased over the period.
Reduced income with a guaranteed maturity value
Conversely, you may look towards a reduced income on the 10-year plan but a guaranteed maturity value, which would include an element of capital appreciation. An example of this type of plan is as follows:-
Income plan purchase price: £100,000
Duration: 10 years
Annual income: £5000
Guaranteed income: £50,000
Guaranteed maturity value: £95,000
Income plus maturity value: £145,000
Upon expiry of the fixed-income plan, the holder would see £95,000 returned to their pension plan, having also received £50,000 in income over the period.
Is this not similar to a drawdown?
While there are similarities with this type of third way pension product, there is also a guaranteed element of investment return in the maturity value. In theory, income plan holders get the best of both worlds; a guaranteed income, an element of capital appreciation on the balance and a guaranteed maturity value at the end of the plan.
Summary
There are now several options for those approaching retirement, with the potential to mix and match the various products. It comes down to the degree of risk you are willing to take and the level of security you require. Consequently, it is vital to discuss the options with your financial adviser at the earliest opportunity.
Whether you are approaching retirement or in retirement, please get in touch, and we can review your circumstances in more detail.