Blending retirement income options

Any additional income such as bonus or overtime then helps fund one-off expenses such as holidays, Andrew Tully, pensions technical director of MGM Advantage, points out.

And he says hopefully any nest-egg they build up will be there if they need to pay for large one-off expenses, such as repairs to their house.

Mr Tully says MGM Advantage’s research shows many people would like their pension savings to continue to operate in the same way. Essentially, they would like to see a portfolio approach with different pots serving different purposes.

He says their state pension and some element of guaranteed annuity provide the base that replaces their salary – and they know whatever happens, however long they live, this money will keep appearing in their bank account each month. This will fund their basic costs such as food and heating.

Another tranche of their pension could provide a flexible income to fund one-offs such as holidays – and this could be provided by an investment-linked annuity or drawdown, he adds.

Finally, Mr Tully says some can be left untouched or in drawdown, as a nest-egg to cover one-offs and to pass onto family following death.

It is important to establish how much a client would expect to spend each year in retirement, says Simon Massey, wealth management director of MetLife.

Plotting out a year in retirement should include all utilities, holidays, health, basic living costs, etc, and how much other assets or income do they have – including state pension, private pensions, investments, bank accounts, potential for downsizing their home, etc.

Mr Massey says there is also the choice of taking tax-free cash - usually a quarter of the fund - and either to use that to generate an income or to meet some needs for capital such as repaying a mortgage, house decorations or a holiday of a lifetime.

An adviser will also want to address a detailed list of other considerations including:

• tax implications;

• the impact of inflation;

• partner provision;

• a bequest or legacy;

• paying for health or care needs;

• the trade-off future growth for certainty;

• market conditions and the attractions of remaining invested for future growth; and

• the attraction of guarantees to protect against market falls.

Mark Stopard, head of product development at Partnership, says using a client’s goals [for example do they want to travel in early retirement and are happy to live a more simple life as they age] provides an idea on what each aspect needs to deliver.

One way that is proving popular is looking at essential income versus discretionary income, he notes.

For example, Bob Smith needs £12,000 per year in retirement to maintain a basic standard of living that he is happy with.

As he receives a state pension of £8,000 and £2,000 from a company DB scheme, his adviser recommends that he takes out an annuity which provides him with an additional £2,000 per year [linked to the RPI].

He can then use the remainder of his pension assets to either fund his discretionary spending [such as holidays] or take additional investment risk – safe in the knowledge his bills will always be paid.

Mr Stopard says this could be looked at as a tiered income approach. He adds one key issue when considering how any retirement income sources can interact is tax.

If, for example, your client has chosen to go into drawdown, then Mr Stopard says they may wish to take taxable lump sums in February and then at the end of April so they can use two different years tax allowances.

Inheritance tax is another important consideration for many under the new pensions rules, he adds.

Your clients can also pass on their drawdown fund and annuity death benefit to their beneficiaries when they die [under 75 it is tax free and over beneficiaries will have to pay their marginal rate of income tax].