Since Pension Freedoms were introduced in 2015, Annuities have fallen in popularity. Instead, many modern retirees prefer to choose the flexibility offered by other options. But Annuities can still provide an excellent way to create a reliable base income for financial security throughout retirement.
What is an Annuity? It is a product you purchase with your pension fund that then delivers a guaranteed income for the rest of your life. Traditionally, retirees took the money accumulated within a pension and used this to buy an Annuity, which then delivered a defined and guaranteed income. However, with more options available than ever before, Annuities have fallen out of favour as the Pension Freedoms now offer more choice.
Statistics from the Financial Conduct Authority (FCA), show more retirees are choosing Flexi-Access Drawdown, where pension savings usually remain invested in the pension fund and a flexible income can be withdrawn to suit needs. Between October 2017 and March 2018, 33,975 new Annuity sales were made. This compares to 90,504 pensions entering drawdown for the first time during the same period. Despite this trend, considering an Annuity and the benefits they offer will still be worthwhile for some.
Building a retirement income
Creating an income that will provide the lifestyle you want in retirement can be complex. It will probably be made up of several different streams and may include:
- State Pension
- Final Salary Pensions
- Annuity
- Lump sums withdrawn from a Pension
- Flexi-Access Drawdown
- Investment portfolios
- Savings
- Property
- Flexible working
With so many different options, it can be challenging to decide which options are right for you and how your needs may change throughout retirement. There are also other factors to take into consideration, such as tax-efficiency, that may affect your decision. Some financial decisions that you make in preparation for retirement are irreversible, as a result, careful consideration should always be taken.
Creating a base income
Base income can be defined as the income that will be required to cover your essential living costs. So, the first step is to calculate how much you need to cover the basic costs of living which may include mortgage payments, utility bills and groceries, for example. In addition to this, you should also consider what is essential for the retirement lifestyle you want to achieve, such as an income to socialise with friends each week or the ability to take a holiday each year.
For many, the State Pension will provide a foundation that you can rely on throughout retirement. However, with the current State Pension paying £168.60 per week (£8,767.20 annually) with a full National Insurance record, it is likely you will need to supplement this with other sources to cover all the basic costs of retirement.
This is where an Annuity can prove useful. While other ways to access your pension can deliver an income, the fact that an Annuity is guaranteed can give you confidence that you will be able to pay for essential items. Having a stable, guaranteed income that you know you can rely on helps to solve several income challenges you may face in retirement:
- Longevity: Nobody knows how long they’ll live for, making it difficult to know how long your retirement savings need to last for. Many of those approaching retirement also underestimate their life expectancy, a mistake that could mean they run out of money in their later years. As an Annuity provides an income for life, it can remove this worry.
- Sustainability: Should you choose to access your pension through Flexi-Access Drawdown, your pension will typically be invested and, as a result, the value may fall as well as rise. Combined with longevity, this can make it challenging to know how much you can sustainably withdraw at different points in retirement. Again, taking unsustainable amounts could place your future financial security at risk.
- Inflation: It’s important to consider the effects of inflation too. The rising cost of living can have a serious impact on your retirement income if it’s not delivering returns that keep up with this. A 2% increase in inflation each year may sound small but over a 30-year retirement, the impact can be significant. When purchasing an Annuity, it’s often possible to link the income to inflation, maintaining your spending power.
Combining financial security with flexibility
There are clear benefits to choosing an Annuity to build the base income that you require. However, the flexibility offered by other pension withdrawal options can be an attractive way to provide the additional income you need to live the lifestyle that you desire.
When you decide how to access your pension, it is important to note that you don’t have to choose just one option. Pension Freedoms mean you can blend the option to create a financial income that suits you and your retirement aspirations. For example, you may choose to access 25% of your pension as a tax-free lump sum to kick off your retirement and tick off some experiences on your bucket list. You could then purchase an Annuity that will ensure the basics are covered for the rest of your life, using Flexi-Access Drawdown for the remainder, allowing you to take a flexible income when you want.
If you are approaching retirement and are struggling to understand how best to draw an income, please contact us. Taking your goals and ideal lifestyle into consideration, we’re here to help you build a retirement income that provides security and freedom.