Annuity rates are at record lows and long-term uncertainty looms in the wake of the Brexit vote. How can you plan your retirement income under these conditions? Pensions expert Billy Burrows offers his own five-move solution for taking back control.
Since the country voted for Brexit on 23 June there has been both good and bad news for those with defined contribution (DC) pensions. Both will be a major consideration for anyone trying to plan for retirement in the near future.
Start with the goodâ¦
The good news is that the stock market has remained buoyant, despite some initial set-backs, so those invested in shares will have fared well. The FTSE 100, the index that shows the ups and downs of the UKâs top 100 companies, rose 8 per cent between 23 June and 16 August, while the FTSE 250 rose nearly 3 per cent. In plain English this means that if your pension pot is invested in a balanced portfolio of shares, you should have seen an increase in the value of your pension funds.
Now the bad news
Of course there is also a downside. Interest rates have been cut, so the yields on both gilts and corporate bonds have plummeted. Another obvious result of the Bank of Englandâs decision to cut the base rate to 0.25 per cent is that you will receive less interest on any cash held in your pension fund.
However, the yield on gilts is a more serious issue for many pensioners. Gilt yields have fallen to their lowest levels for 300 years, with the result that annuity rates have also plummeted to their lowest levels ever. To put this in the simplest terms, someone with a pension pot of Â£50,000 will now get several hundred pounds less each year than they would have been able to at pre-Brexit rates.
So what is a retiree to do?
If your retirement is imminent â meaning youâll soon have to decide how to use your pension to provide yourself with an income â then this will be something of a blow. However, by thinking about the issues in more depth and taking advice on your options, you should still be able to construct a plan that suits you.
Whether you were initially planning on an annuity or a drawdown plan, here is your five-step plan of action.
1. Donât panic. Hasty decisions are rarely the right ones. There isnât a quick âsilver bulletâ solution, but a carefully planned one is still very achievable.
2. Understand the reasons why interest rates have fallen and why shares have held up. Think about how this might impact your pension in the future.
The reason why interest rates have been cut is that the Bank of England thinks there may be trouble ahead for the economy â resulting in lower economic growth and fewer jobs. The EU referendum result has created widespread economic uncertainty, making it harder for businesses to plan for the future, and this is what has cast a shadow on the UK economy. The Bank hopes that by cutting rates it will encourage businesses to invest in new opportunities, because it is cheaper to borrow money. The rate cut should also (in theory) encourage consumer spending, thereby boosting confidence in the UK economy.
Although the stock market has been doing well since the Brexit decision, equity prices could still fall in the coming months as the âBrexit bounceâ wears off and uncertainty reasserts itself. This means that, unless your pension is carefully invested in the most resilient funds, the value of your pension fund could fall as well.
This is a less of a problem for people who are still some way off retirement, because they will have plenty of time for the stock market to recover and restore the value of their pensions. However, for those close to retirement, or already taking income from a drawdown plan, such a dip could have serious consequences. Itâs therefore a good idea to talk to your adviser about how your pension is invested and whether or not it could be made more resilient.
3. Consider all of your options. With the new pensions freedom there are more potential choices than ever for taking an income in retirement. The three main options (after taking your 25 per cent tax free cash) are:
- Taking your pension as a cash lump sum â you pay tax at your marginal rate
- Guaranteed income for life â this is called an annuity
- Taking income directly from your pension pot â this is called drawdown
4. Make a plan. It doesnât need to be complex or go into huge detail, but any plan is usually better than none. In my experience, those people who had a retirement plan, no matter how basic and simple, ended up with better solutions than those simply made their decisions off the cuff.
An example of such a simple plan might be: âI want x amount of guaranteed income to pay the essential bills. Then I want flexible access to the rest of my pension potâ.
Another might be: âWhen we retire, my wife and I want to treat ourselves to a special holiday and do some home improvements. But after that we just want peace of mind and security.â
A third might be: âWhat my husband just said â but he forgot to mention that our daughter is getting married next year, so weâll need some spare cash for that too!â
Whatever your plan, once youâve discussed it with your adviser you can think about which options will help you to deliver it â not forgetting that you have multiple options which you can mix and match as necessary.
5. Get the timing right. This takes us full circle: remember that annuity rates are now at their lowest-ever levels. Meanwhile the stock market is currently healthier, but its future still uncertain â so factor all of this into your planning.
There are many different ways to arrange your retirement income so that you donât lose out from poor timing. For instance, you could consider a fixed income plan for several years so you have guaranteed income, with the option to do something different in the future when there may be more certainty in the financial markets. Alternatively, you could start off with drawdown, making sure you are invested wisely, and then purchase annuities if and when rates improve.
Having advised people on their annuity and drawdown options for over two decades â and being something of an annuities geek who checks the rates every day â I have developed a little motto of my own. I am fond of saying, âI donât know the answer, but I do know the right questions to askâ.
At this moment the most important question is this. How do you arrange your pension income so you avoid the two big hazards: getting locked into todayâs low annuity rates, or bearing the brunt of stock market turbulence with a risky drawdown plan? Navigating between those rocks isnât going to be easy â but I believe it can be done.
About the author
Billy Burrows is an independent expert on retirement income options, with more than 25 yearsâ experience. He is the author of many guides on retirement for both consumers and advisers, and is a regular blogger and media commentator on pension and retirement topics. Follow him at @BillyBurrows