The perfect blend
Cocktail solutions for retirement income aren’t new, but pension freedoms have shaken the idea back into life.
In the wake of pension freedoms, people are re-evaluating what it means to be in retirement. Although the population is generally moving away from annuities as the single destination for their pension savings, many still want the security of a guaranteed income, while others want to retain more flexibility.
People are faced with an assortment of risks in retirement, including inflation, longevity, fluctuating share prices, interest rates and changing health. Unfortunately, there isn’t a single solution that effectively manages all of these. Addressing one risk often counters efforts to combat another.
For instance, annuities are the only way to protect against longevity because income is guaranteed regardless of how long you live. But as income from an annuity is inflexible – and calculated at a single point in time – it does not allow for changing circumstances. Furthermore, if you choose an annuity that provides a level income, there is a danger that inflation will eat away at spending power to a point where future income fails to maintain a standard of living.
Drawdown, on the other hand, aims to mitigate these shortcomings by allowing access to an unrestricted income and maintaining market exposure. But people choosing drawdown have to be comfortable with the risk of future investment returns being less than expected; or worse, the prospect of running out of money.
The fact is that an annuity and drawdown can be combined to provide a solution for your pension; and in practice, retirees who have significant pension wealth tend to want something more sophisticated than a one-size-fits-all approach.
You can designate a pension partially to annuity, partially to drawdown (alongside the new option to withdraw cash lump sums directly from the pension fund) through a ‘blended’ or ‘cocktail’ solution.
A blended approach can meet multiple objectives. For example, by using an annuity to cover essential outgoings (e.g. utility bills, Council Tax and food), the rest of the pension can stay invested to hopefully grow and supplement longer-term goals. If cash is required to fund one-off expenses such as house repairs or holidays, this can be accessed via a drawdown facility, or by taking a lump sum from the invested pension fund.
And the hugely improved death benefit position allowing pension pots (including funds in drawdown) to be cascaded down generations in a tax-efficient way means you might need to balance the need for income from an annuity with the need to keep some back in the pension pot for intended heirs.
Another approach is to remain invested (via drawdown if appropriate) while there is still time to ride out volatility, and go for an annuity later in life. This ensures that if markets have taken a tumble, you aren’t locking losses into an annuity. Individuals who go on to develop health issues later in life may even qualify for an enhanced or impaired life annuity, offering a better rate than a conventional annuity.
People approaching retirement are realising that planning a replacement income is a complex matter and not necessarily suited to a single solution. Free guidance from the government through Pension Wise can only give general recommendations. Sound financial advice – sought before, during and after the point of retirement – will be the key to achieving the perfect blend for most individuals.
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.
The level of income from drawdown is not guaranteed. You may need to reduce your drawdown income in the future; in particular if the performance of your investments is lower than expected, or you live to a greater age than originally anticipated when you chose your initial income level.