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Retirement Planning

The pros and cons of guaranteed income in retirement

By | Retirement Planning

With the introduction of pension freedoms from 2015, those approaching retirement have a much wider range of options available to generate pension income. Although flexible pension options such as Flexi-Access Drawdown remain popular, pension annuities are an alternative that should be considered.

A lifetime pension annuity is a financial product that provides a guaranteed income for life in exchange for a lump sum from your pension pot. As the purchase of an annuity forms a contract with the insurance provider, a lifetime pension annuity will continue to pay the contractual level of income, irrespective of how long you live. The contract is, however, binding on both the insurer and the pension holder, as once a lifetime annuity has been purchased, the decision is usually irreversible.

Weighing up the factors

It is important to carefully consider the positives and drawbacks of an annuity, compared to other options to generate an income from accumulated pension funds, before deciding on any course of action.

Perhaps the biggest advantage of a pension annuity is that the guaranteed income provides certainty. Once in place, the income payments will continue for as long as you live and avoids the potential that you outlive your pension savings if drawing an income via another method, such as drawdown.

An annuity can be arranged on a single life basis, guaranteeing payments for the rest of the pension holder’s life, or set up so that benefits continue to be paid to a spouse or partner in case of death of the annuity purchaser. A further choice is to select a guarantee period, whereby payments will continue for a pre-determined length of time, irrespective of whether the annuity purchaser survives the length of the guarantee period. Each of these options will, however, reduce the amount of income paid.

A pension annuity also avoids the need to consider stock market risk, as the pension savings will have been converted into a guaranteed income. Irrespective of market or economic conditions, the contractual payments will continue. Additionally, as the pension fund has been exchanged for an annuity, no further fund or management charges will be levied.

Whilst pension annuity rates are largely determined by age and life expectancy, enhanced annuity rates may be offered to those with adverse lifestyle factors, such as smokers, or individuals with certain underlying health conditions. Based on underwriting decisions through each insurer, those qualifying for an enhanced annuity may see modest uplifts to the annuity rate offered, as their actuarial life expectancy is shorter.

Drawbacks of lifetime annuities

Whilst the above may make annuities sound appealing, there are drawbacks to consider when guaranteeing an income in retirement through a pension annuity. One of the most serious drawbacks is that once you purchase a pension annuity, the decision is usually final. If your circumstances change in the future, you can’t adjust the pension in payment or resurrect the pension pot. This lack of flexibility can be a major disadvantage as income needs often change through retirement. For example, you may look to spend more in the early years after retirement on lifestyle choices, such as travel, or home improvements. A fixed lifetime annuity does not provide that flexibility, while through drawdown, you can adjust your income to match your spending needs or take a single income payment should an unexpected need arise.

Other than any guarantees that are purchased with a lifetime annuity, the annuity payments will cease on death. In contrast, under flexible retirement income options, such as Flexi-Access Drawdown, any remaining funds can be passed to beneficiaries on the death of the pension holder. This allows the beneficiary to draw a flexible income and effectively allow the value of the pension to cascade down generations. Currently, remaining pension values on death are outside the scope of Inheritance Tax (IHT), further enhancing the attractiveness of the flexible pension options. Despite the change of rules from April 2027, when pension values will form part of an individual’s estate for IHT purposes, the ability to leave residual pension funds to loved ones on death via flexible income methods continues to be attractive and cannot be matched via a lifetime annuity.

Lifetime annuities tend to be arranged on a level basis, which means that the payment stays the same over the life of the annuity holder. Over time, inflation will erode the real value of the annuity income and reduce the purchasing power of the income received. To mitigate inflation risk, you have the option of buying an inflation linked annuity, or an annuity that increases at a set percentage rate each year. This may appear a sensible option; however, the index linked annuity payments start at a much lower income than a level annuity, and it may take many years for the increasing income to match the starting value of a level annuity.

Seek tailored advice

Deciding the best method of generating an income in retirement from pension savings, depends on a range of factors, and the individual’s overall financial position. Annuities can provide certainty and peace of mind; however, the lack of flexibility and inability to pass down residual pension funds to loved ones can help drawdown options look more appealing.

Given that decisions taken at retirement can have lifelong consequences, it is vital that independent and unbiased advice is obtained before reaching a conclusion. Our experienced advisers will take a holistic overview of your financial circumstances and give tailored advice on both flexible and guaranteed pension income options. Speak to one of the team to discuss your retirement income needs.

Why you need to start retirement planning earlier than you may think

By | Retirement Planning

To anyone in their 30s or 40s, retirement plans may seem like something that can be put off until a later date. Multiple financial pressures such as paying down a mortgage, covering the costs of growing children or funding further education costs often mean that long-term financial planning takes a back seat.

It is often the case that people begin to focus on their retirement plans when they accept that retirement is only a decade or so away; however not taking control of your pension plans earlier may have financial consequences, as regularly reviewing your pension arrangements is crucial to ensuring a secure and comfortable future. With constant changes in pension legislation, stock market volatility and potential changes in your financial circumstances, it is important that your retirement plans remain on track to meet your goals.

Identify savings gaps

Many people underestimate the value of pension assets needed to maintain their desired lifestyle in retirement. The full basic State Pension, whilst increasing to £230 per week from 6th April 2025, can only support a very basic lifestyle, and political parties have openly acknowledged that the so-called “triple lock” is under threat. This could mean that increases to the State Pension could potentially fall behind the cost of living over the next decade or two. It is therefore important to start thinking about the level of income that you would like to aspire to achieve in retirement and consider how your existing plans are placed to reach this goal. This could identify savings gaps that could be filled by increasing pension contributions, which may be easier to afford if made incrementally over a longer period.

Working with an independent financial planner can help review your existing pension contributions and provide advice on the level of additional savings that may be required to meet your goals, and how to make contributions as tax-efficiently as possible.

Investment performance and the need to review

Defined Contribution pension funds are typically invested in a mix of assets such as equities, bonds, and property. Modern workplace pension contracts need to offer a “default” investment option, in which pension investments are held, unless a separate investment strategy is selected. The default investment option usually provides an element of auto-adjustment, known as lifestyling. Whilst this approach can vary from provider to provider, the premise is that in the early years, when you are some distance from your retirement age, the fund will invest largely in equities, with the aim of achieving long-term growth. As you nearer retirement, the mix of assets is automatically adjusted so that the allocation to lower risk assets is increased, with the adjustments eventually reaching a position where 25% of the portfolio is held as cash, with the balance held in a mix of assets, at the chosen retirement date.

For those who do not wish to take control of their pension, this approach is designed to avoid the potential for the value of pension savings to fall heavily just before retirement; however, taking control of your pension investments and making investment decisions, can produce outperformance and lead to a greater pension fund value at retirement. Furthermore, most lifestyle approaches are invested in passive investment funds only, which by their nature, will only ever track their benchmark index. Actively managed funds, invested in the same sector as a passive fund, could potentially outperform significantly, and considering your pension investments earlier in life can give more time for investment decisions to have an impact on your pension fund value, and the income it can generate in retirement.

Building a cohesive strategy

Most people accumulate multiple pension pots from different employers over their careers, and designing a cohesive overall strategy across multiple pensions with different providers can be complicated. Older pension contracts often carry higher ongoing costs than modern pension arrangements, which can impact on performance over time, and many only offer a limited range of fund options from which to create a good performing investment portfolio.

Consolidating older pension arrangements into modern style platform pensions can help bring order to deferred workplace pensions and provide the opportunity to put a cohesive investment strategy, designed to meet your attitude to risk and goals, in place. Undertaking such a consolidation exercise earlier in life provides greater time for the new investment strategy to outperform, and in doing so, can help the value of your pension fund reach a level required to provide a more comfortable retirement.

Working out a financial plan

Starting to consider a retirement plan can be a daunting task; however, working with an adviser can help identify your financial goals and priorities, and consider the level of contributions required to meet your retirement plans. Independent financial advice can also be vital when considering options in respect of existing pension arrangements you hold. Consolidating older style arrangements into a single plan is not right for everyone, as some pensions set up years ago can contain valuable benefits, such as guaranteed annuity rates or protected tax-free cash, which may be lost on transfer. A comprehensive independent review of your pensions can help identify such special features and critically analyse the charging structure and options within your existing arrangements.

Financial advice can also rearrange pension investments into a cohesive strategy, designed to meet your attitude to risk. Modern pension platforms provide access to a very wide range of investment funds from across the marketplace, thus avoiding the restrictions imposed by many workplace pensions. Speak to one of our experienced advisers to discuss your existing pension arrangements, and build a financial plan designed to meet your retirement goals.