Creating Income in Retirement
Why you may not want an annuity yet
You may defer annuity purchase providing you have other assets to live on or are able to draw income from your fund gradually, for instance, by using income drawdown or phased retirement. These are flexible ways of taking your pension in stages while leaving your pension fund invested on the stock market so that hopefully it can continue to grow. Both these arrangements are relatively high risk and should only be undertaken after you have taken independent financial advice. They are generally not recommended for those with pension funds smaller than £250,000.
Under the pensions' regime which came into effect in 2006, you are no longer forced to purchase an annuity at age 75 but you are required to use your pension savings to create a guaranteed income by the time you reach the age of 75. This alternative is called Alternatively Secured Income and is intended for those with what the HM Revenue & Customs calls principled objections to the pooling of mortality risk. However, the absence of any lump sum death benefit as part of this arrangement may make this option unattractive to most people.
You will also need expert advice on investing your pension fund as it will need to grow to cover the costs of the plan. The principal risks are that your pension fund might drop in value because of poor investment returns and/or that annuity rates might fall further.
Using an unsecured pension - the post A Day form of income draw down - you may take up to 25% of your fund as a PCLS and leave the balance invested. You may then take an income, if you wish each year, of between zero and 120% of what a level, standard annuity would pay to someone of your age. The crucial difference between an unsecured pension and the previous income draw down rules is that you are no longer obliged to take any income each year.
After age 75, you may continue doing a more restricted form of income draw down, called taking an alternatively secured pension or ASP. The level of income that can be taken from the pension fund is based on a table produced by the Government Actuaries Department (GAD). Since 6 April 2007, when the limits were tightened, you must take between 55% and 90% of the relevant GAD figure.
In phased retirement, also known as "staggered vesting", instead of buying one single annuity contract with your pension fund, each year you buy one or more small policies. Some phased retirement plans may include several hundred small annuity contracts. In this way your pension fund is turned into annuity income over a period of time.
You maintain your income in phased retirement by reducing the amount of cash taken directly from your pension fund each year as income from the annuities you have purchased rises over time. Phased retirement offers almost similar flexibility to income drawdown and is also not generally recommended for those with pension funds of less than £250,000.
Guarding against inflation
Company pensions are required, at least in part, to be increased each year but few (with the exception of public sector schemes) provide full index-linking because this is extremely expensive.
You may purchase an index-linked annuity although this is expensive and will result in your initial income being around one third less than an ordinary, level annuity. Alternatively, you can arrange for your annuity to increase by a set percentage each year - say, by 3% or 5%. Again, this will reduce your initial income substantially.
Other options are to take a with-profits or unit-linked annuity. In common with annuity deferral, these schemes expose your pension funds to market risk. You are counting on your pension annuity to grow over the years so that you can look forward to a rising income over time. However, if the underlying investments do not perform as expected, you could see a drop in income. There will be a minimum limit below which your annuity income cannot fall. What you will actually get will be dependent on the return from the underlying investments. Investment-linked annuities should only be considered after taking independent financial advice and only by those people who have other assets to live on, in case the annuity income drops.
Getting the best annuity you can buy
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