Last year's carnage in the stock market put many people's retirement plans into disarray. If you're suffering a depleted portfolio you may have had to put your retirement plans on hold indefinitely.
But, if you've dared to check your pension fund lately, the 25 per cent rally since the stock market's March low point means that retirement may be coming back within reach. Nevertheless, if you're approaching retirement you have difficult decisions to make. First, it's impossible to say how long the markets will take to recover to their 2007 highs. Second, you have the difficult decision as to how to convert your pension pot to income. This is always a complicated issue but has become more so in an environment of low annuity rates.
Recent stock market gains may have given retiring investors increased pension pots. However, those pots have to be converted to income and for most people, some of the rise in value of their pot has been cancelled out by falls in annuity rates.
Here is a quick summary of what has been happening to annuity rates.
Following the credit crunch, annuity rates soared on the back of the money markets becoming frozen. More recently, quantitative easing caused gilts to soar, prompting their yield to slump - resulting in an extraordinary 20 annuity price cuts in March alone (according to Hargreaves Lansdown). A 65-year old man retiring today with a £100,000 fund is now £835 a year worse off than last July or a massive £18,000 over the course of his normal lifespan.
After several months of falling rates, level annuity returns stabilised in May. The top rate from Norwich Union was unchanged at £6,440 (male, aged 60, £100,000 purchase). Female rates also held firm, with the top rate from Norwich Union unchanged for the month at £6,100 (female, aged 60, £100,000 purchase).
Tim Whiting, director at Alexander Forbes Annuity Bureau, says: "The worst of the double whammy of falling interest rates and quantitative easing seem to have worked their way through the system and the sharp falls in level annuity income seen in recent months appear to have slowed, which is good news for people approaching retirement.
"As rates have fallen, however, it is even more important that people shop around for the best possible annuity rates - in our experience, people could improve their retirement income by up to 18 per cent simply by using the open market option to get the best possible rate. Over a 30-year retirement this could mean up to £34,776 or more extra income for a person retiring with a pension pot of £100,000."
Although level annuity rates have stabilised since falling 10 per cent from last summer's six-year highpoint, today may not be the best time to sign up your pension pot for a level annuity.
According to Hargreaves Lansdown, the sheer scale of government borrowing (£700 billion-plus in the next five years) may cause inflationary pressure in the medium term, meaning that annuity rates could be set for a big jump in a few years, as inflation typically pushes gilt and bond yields upwards.
If you want to work some inflation protection into your annuity there's not much good news. According to Alexander Forbes Annuity Bureau, index-linked annuity rates continued to slide in May with Canada Life shaving its table-topping rate by £111 to £3,769 in May (male, aged 60, £100,000 purchase). The best inflation-linked annuity income has now fallen by more than £150 per annum in just two months.
The immediate outlook for annuity pricing is much harder to predict as there are conflicting forces operating on their underlying assets. But that uncertainty is a huge burden for anyone wanting to start a life of leisure in the next few months.
So what are your options? Hargreaves Lansdown is recommending income drawdown as a stop-gap measure to pay for today's retirement income. Under this route, you can take your tax-free lump sum now and use it to supplement income, leaving the rest of the fund invested with the hope that share prices and annuity rates will recover. But there is still the risk that stock markets could take some years to pick up. Plus there is also the risk that you could see your pension savings decrease further, so it is not appropriate for those unwilling to accept the associated risk.
Nigel Callaghan, pensions analyst at Hargreaves Lansdown, says: "Drawdown offers income today, while keeping a retiree's options open to benefit from possible higher future annuity rates should inflation return further down the line."
Drawdown also offers younger retirees in good health the ability to postpone annuity purchase to a later date in anticipation of being in poor health at old age enabling them to benefit from an enhanced poor health annuity at a later date.
However, a downside to income drawdown is that the Government Actuary's Department (GAD) rate - which is used to regulate how much income can be drawn directly from a pension pot - has fallen, meaning that you may not be able to draw as much income from your pension as you would have wished.
The GAD rate is based on UK gilts (15 years) from the FTSE UK Gilt Indices, as published in the Financial Times for the 15th day of the calendar month. Before the age of 75, retirees can take up to 120 per cent of GAD rates as income from their pension pots. After age 75 they can take between 55 per cent and 90 per cent of GAD rates. In April, the GAD rate was an all-time low of 3.25 per cent, but has risen slightly since to 4.04 per cent in May.
Several self-invested personal pension (Sipp) providers say that investors should consider 'scheme pension' as an alternative to income drawdown that will allow a greater level of income to be drawn. Under 'scheme pension', an actuary will decide how much income can be taken based on your personal circumstances (including health) and the yield within your pension pot. This option is offered by a handful of specialist Sipp providers, including TM Sipp Services. You will normally need to employ the services of an independent financial adviser (IFA) to help set up the scheme. You can use the Find an IFA service at www.investorschronicle.co.uk to search for an IFA with specialist pension qualifications.
For more on 'scheme pension', see the article in next week's issue of Investors Chronicle.
