Don’t let the credit crunch eat into your pension
Global stockmarkets have had a rollercoaster ride recently as the credit crunch in the US continues to raise hackles among investors.
Sinking share prices have also caused concern among some pre-retirees, many of whom have seen their personal pension pots reduced by up to 20% since the summer. Experts estimate that as many as 350,000 people due to retire in 2008 may now have to stay working until their funds recover.
If you were planning to retire in the next year and your pension is linked to the equity markets, then your biggest concern is probably maximising the value of your pension savings.
Nigel Callaghan, pensions expert at Hargreaves Lansdown, suggests deferring retirement by a few months to give the markets a chance to fully recover. However, there is no guarantee how long this will take.
If you are unable or unwilling to defer retirement, and have enough cash savings to provide you with an income for six months, then Callaghan recommends you keep your pension savings invested - again to give them time to recover any fall in value.
He added: “It’s important that those retiring are aware that there are a number of options available to them. By making the right decision now, you could ensure you enjoy a far wealthier retirement.”
If you still have anything between five or 15 years to go until you retire, then the current market turbulence could actually be a good thing for your pension pot.
Taking advantage of lower share prices by making regular pension contributions could pay off down the line.
Callaghan said: “If investors are making regular contributions through the turmoil, then 20 years from now they may find that this has been a very profitable period of investing.”
Annuities: buy now, pay later?
Picking an annuity is one of the most important decisions you make as part of your retirement strategy, as once you make the purchase there is no going back.
There is no requirement to take an income from your pension until you hit 75 – and with stockmarket turbulence eating into pension pots, experts predict that many retirees will delay purchasing an annuity until things settle down.
But this might not be the right approach. According to Defaqto, a financial research company, delaying the purchase of an annuity could actually leave you worse off.
By looking at the best annuity rates currently on the market, it found that a 64-year-old man with a pension fund of £100,000 could be eligible for an annuity of £7,234 a year for the rest of his life. However, if he waited until he was 65 to take an annuity, he could be eligible for an income of £7,410 a year.
While this is an annual increase of £176, he would still have forfeited his first year’s income of £7,234 and would have to survive for 41 years to make up the difference.
Even if he his pension pot grew by 6% in the year between him being 64 and 65, the resulting break-even period would still be 12 years.
Matt Ward, a wealth and pensions consultant at Defaqto, said: “Choosing the right time to take your annuity is very specific to your individual circumstances and to your view on future annuity rates, even if your pension pot is protected by being in money or near money assets.
“So when you decide to take your annuity is just as important as getting the right annuity from the right provider at the right price.”
Of course, Defaqto’s research assumes that annuity rates will remain
the same for a year. Without a crystal ball it is impossible to verify this. Defaqto admits there is no guarantee that annuity rates will look more or less attractive in the future.
But it adds that with the Bank of England expected to cut interest rates in the coming months, then annuity rates could also come down.
According to Hargreaves Lansdown, annuity rates are at a four-year high at the moment, being one of the few financial products that are actually benefiting from today’s economic climate.
Callaghan says the annuity market is moving towards more specific pricing – as seen in the development of enhanced rates for people with lower life
Greater life expectancy has eroded the value of annuities over the years. This trend is expected to continue, with insurance companies increasing offering more competitive annuities for people with reduced life expectancy, such as smokers. This could mean that ‘mainstream’ annuity rates will only get more unattractive going forward – another reason, perhaps, to buy now instead of later.
Callaghan said: “People in poor health will benefit from this but the healthy will pay with less attractive annuity rates.
“So unless you think that your pension pot is likely to get bigger between now and when you buy an annuity, or if you think you are likely to develop an illness in the future which would qualify you for an enhanced annuity, then it is not a bad time to buy an annuity.”
If you do decide now is the time to buy an annuity, then it is important to shop around for the best rate using independent sources such as the Financial Services Authority. Research suggests there is a 15% difference between the best annuity rate and the worst, and as annuities are inflexible you could end up thousands of pounds better off by using the Open Market Option.
Although the majority of retirees choose to take income from their pension using an annuity, experts say increasing numbers of people who don’t need a fixed income and want to get more out of their money are opting for income drawdown.
One advantage of income drawdown is that many contracts allow you to draw money from a particular investment fund.
Callaghan said: “Many investors are drawing income from their cash or bond holdings and are leaving their equity backed ones untouched. This is giving time for their investments to recover.”
He adds that by using income drawdown, investors can take a tax-free sum of cash to generate an income for a few years, leaving the rest untouched in their pension pot until the stockmarket has “recovered”.
“Losses are only on paper at the moment – anything that means the paper losses are not crystallised or are kept to a minimum is to be encouraged.”
Open market option
People who have a money purchase or defined contribution pension, at retirement must use their fund (minus an optional 25% as tax-free cash) to purchase an annuity. As the annuity market is very competitive and rates differ vastly between annuity providers on a daily basis, the open market option is your right to shop around and buy the annuity from the company offering the highest rates at that time.
An alternative to an annuity, income drawdown (also known as an unsecured pension) allows you to take income from your pension fund while the fund remains invested and so continues to benefit from any fund growth. The drawdown of income has to be calculated carefully as taking too much income could exhaust the pension fund so experts say the annual drawdown must not exceed what the assets would normally yield in an average year. The invested pension fund could also be hit by market turbulence and the value of the assets could fall.
The Financial Services Authority is an independent non-governmental body, given a wide range of rule-making, investigatory and enforcement powers in order to meet its four statutory objectives: market confidence (maintaining confidence in the UK financial system), financial stability, consumer protection and the reduction of financial crime. The FSA receives no government funding and is funded entirely by the firms it regulates, but is accountable to the Treasury and, ultimately, parliament.
In exchange for any lump sum – usually your pension fund – an annuity is “bought” from an insurance company and provides an income for life. When you die, the income stops. Annuity rates fluctuate daily and depend on your sex (although from 21 December 2012 insurers will no longer be able to use gender as a factor when calculating annuities), age, health and a number of other factors, so you have to pick the right one and, once bought, its terms cannot be altered, so seek financial advice.