Knowing how best to invest your pension fund is a critical decision which thousands of people face as they approach retirement. The broad choice for those without a final salary scheme generally focuses on purchasing a conventional annuity, or opting for an unsecured pension. With a standard annuity, you get a secure and dependable income for the rest of your life but your income will be fixed every year and will not increase. When rates for annuities were more favourable, this option was more appealing. However with rates having fallen steadily for the last fifteen years, the annuity option becomes less and less attractive to retirees.
Howard McWilliam in the Daily Telegraph notes that…”…twenty years ago a pension fund of £100,000 would have secured an income of £15,600 a year for life. Today, those retiring with the same fund would receive a pension of £5,860.” So with rates falling, many turn and consider the alternative option of income drawdown. But, income drawdown incurs a much higher element of risk as your fund remains invested in whatever commodity you choose. This can be equities (higher risk) or bonds and gilts (lower risk), or a mixture of both, all of which are usually managed on behalf of the investors by a fund manager. But for those who do not want to expose their nest egg to the pitfalls of the markets, what choice do they have when annuity rates are so dismally low?
One solution are so-called Third Way Annuities, which is a US name for variable annuities. These are a halfway house between conventional annuities and income drawdown which offer retirees the chance to invest some of their fund, while still maintaining a guaranteed level of income. However are there associated costs with this type of product as your investments have to be actively managed…Tom McPhail of Hargreaves Lansdown says that …”…you can be looking at costs of over 3pc a year, which can eat into returns.” But with the housing market uncertain which in turn decreases the attraction of equity release, a third-way annuity could turn out to be the best solution for those not wanting to hedge everything on income drawdown.
