Income options for clients reaching retirement

Annuities offer a known sum of income for the remainder of the client’s life. They are easy to understand, simple to set up and inexpensive to administer.

It is possible to increase income each year by a fixed percentage or in line with inflation through an index or inflation-linked annuity, but to do this a lower starting income must be taken.

However, according to Andrew Tully, pensions technical director at MGM Advantage, few people choose this option as it often takes until the person reaches their 90s before they will benefit.

“Most people also prefer higher income in the early years of their retirement when they are more active.”

Lifetime annuities can take health and lifestyle issues, such as for those with medical conditions or smokers, into account when determining income. Such ‘enhancements’ can provide income of around 20 per cent more than a conventional alternative.

For those who do not want to be locked into an annuity, drawdown provides more flexibility of income and allows savers to benefit from investment returns.

Drawdown has become a fundamental part of the retirement planning process even for those with modest pension pots of £50,000, or less if they have other sources of income, says Alastair Black, head of customer income solutions at Standard Life.

Capped income drawdown allows the client to withdraw income directly from their existing retirement fund, without the requirement to purchase a separate product.

Flexibility is the selling point here, says Fiona Tait, business development manager at Scottish Life.

“The client can choose how much to withdraw from the fund – within limits, where they should invest their portfolio and when to purchase an annuity.”

Unlike capped income drawdown, the relatively new option of ‘flexible’ income drawdown does not apply any income limit and is available to those who have a secured minimum income of at least £20,000 a year.

Other new options sometimes referred to as ‘third way’ are fixed-term annuities and variable annuities, despite perhaps fitting more accurately into the drawdown category.

Fixed-term annuities give people a certain income for a period of time alongside a guaranteed maturity value at that time, while variable annuities are drawdown contracts with income guarantees to protect clients from investment downturns.

It can be a good idea to use a combination of products to provide a balance of flexibility and security, points out Ms Tait, who adds this can be particularly beneficial in the early years of retirement.