Pick 'n' mix
Recent political and economic events highlight the need to make the most of the choices available to generate income in retirement.
Uncertainty in the UK economy following the shock of the Brexit vote has accelerated the decline in the incomes paid to those who convert their pension pot into an annuity. Providers have reduced their standard annuities by around 11% since the EU vote, with larger decreases for some other types of annuity1.
Annuity pay-outs reflect returns on government bonds, or gilts. When gilt yields fall, annuity rates also fall. One of the reasons annuity rates have fallen since the referendum is that uncertainty about the economy has prompted investors to retreat to the perceived safe haven of gilts, forcing down their yields.
The Bank of England’s efforts to limit the extent of an economic slowdown have only served to make the situation worse. After the announcement of a 0.25% cut in interest rates and £60bn in gilt purchases, the yield on a UK 15-year gilt fell to 1.14% on 4 August and had dropped to 0.92% late last week2.
The fact that yields are being artificially depressed will be a further blow to those who are planning to lock in an income from their pension pot. Although the fiscal stimulus is designed to keep the economy ticking over, retirees will rightly ask if they are being factored into the Bank of England’s thinking.
It’s not clear if or when the decline in gilt yields will be reversed, but those who delay buying an annuity in the hope that returns will improve may end up disappointed.
“In truth, gilt yields have been in decline for years,” says Ian Price, Divisional Director at St. James’s Place. “Until economic policy starts to normalise and interest rates start to rise again, gilt yields will probably remain low, and therefore so will annuity rates.”
But Price says that annuities have a unique benefit that many savers rightly continue to find attractive. “There’s no other way to insure yourself against outliving your savings. If you reckon you’re going to spend 20 or 30 years in retirement, annuities still represent great value.”
“Furthermore, if you smoke, drink heavily, or have health problems, then you could qualify for an ‘impaired life’ or ‘enhanced annuity’, which can offer much more income than a standard annuity, as pay-outs reflect your reduced life expectancy,” he observes.
Nevertheless, the low gilt yield environment, exacerbated by the break with Europe, will influence the decisions people make when securing a pension income. Yet, the introduction of pension freedoms in April 2015 may have offered those with defined contribution (DC) pensions a way to help mitigate the impact of economic policy resulting from the referendum.
Pension freedoms have opened up greater opportunities for people to defer the purchase of an annuity, and instead, they can make their own investment decisions while withdrawing any amount of income they like through drawdown.
This does however pose a number of challenges, especially when markets are volatile. The storms experienced in the aftermath of the EU vote may have subsided, but sentiment in the post-referendum era is likely to remain fragile until there is some certainty about how the UK will trade with its previous EU partners.
It’s a good reminder to those who keep their pension invested in retirement of the importance of diversifying their portfolio to help cushion themselves from the impact of sharp movements in the market.
The potential for more bumps along the way also highlights that those in drawdown may need to consider scaling back future withdrawals, as taking money during stock market downturns will make it much harder to rebuild a portfolio to a position of strength.
But putting withdrawals on hold for any length of time can prove tricky if there are no other sources of income. That’s why a two-tier approach is worth considering: put part of your pot in an annuity, then invest the rest.
“An annuity will give you a guaranteed level of income for the rest of your life, regardless of stock market fluctuations. The pension that’s invested can provide extra income when you need it,” says Price.
With the prospect of slower global growth and bouts of market volatility, a carefully structured and regularly reviewed investment strategy will be needed to take advantage of the greater freedom we have to use our pensions how we like.
1Based on male age 65, £10,000 purchase, single life, guaranteed 5 years and level payments. www.williamburrows.com, 16 August 2016.
2Investing.com, 16 August 2016
The value of an investment with St. James’s Place will be directly linked to the performance of the funds you select and the value can therefore go down as well as up. You may get back less than you invested.