New rules to bring greater flexibility

The regulations also confirm that pensions will retain many of their traditional advantages, such as tax relief on contributions.

For many investors, retirement will cease being a transactional process to turn accumulated savings into income, but instead become a more fluid process that may incorporate a suite of products to meet particular, changing needs.

However, that does not necessarily mean that new products are required in order to meet these needs, and many investors will find the current offerings will be sufficient. But for those looking for something different, more solutions are expected to emerge as the year progresses.

In spite of much negativity, annuities will remain a popular choice for investors who are seeking secure lifetime income for at least part of their funds.

Although the underlying investments have moved on from gilts, annuities continue to be invested predominantly in high-quality corporate bonds, enabling them to provide stability and peace of mind when it comes to ensuring investors receive a regular income. Annuities may also offer smokers or those in poor health higher rates of lifetime income.

The new rules allow for greater flexibility around how income is paid by an annuity. For example, the income payment may mimic the different models for typical retirement expenditure, offering higher income at the start and lower payments through the mid-retirement years, which increase again in later life. However, the terms will be set when the policy is purchased, making annuities the least flexible of all retirement options.

Fixed-term annuities pay a regular income for a fixed period, confirming a guaranteed lump sum known in advance, which can be reinvested in another retirement income solution or taken as a lump sum.

The guaranteed maturity sum can be delivered through a product that guarantees the return of a set value at a certain time, but it can also provide a level of growth, such as a structured deposit plan. These are useful when income is needed but when the investor does not wish to make a final decision immediately.

Shorter-term guaranteed income can meet a shortfall until the investor starts to receive income from another pension, or if they believe their circumstances may change. However, investors using fixed-term annuities will share some of the limitations suffered by annuities and they may find the solutions available at the end of the term are not as favourable as expected.

Many providers will look to offer a range of solutions to provide annuity-style income security, but through income drawdown. Unit-linked guarantees underpinning drawdown plans have been available for some years, offering protection against investment downturns. These give retirees the potential for investment growth, but the guarantee imposes a performance target that must be exceeded before growth is passed on to the fund.

The new rules have prompted the emergence of alternative investment solutions to solve the conundrum of how to provide some certainty over income and the necessary longevity of the fund.

Multi-asset funds can invest in a broader range of assets to provide an income and thus beat the rates available on annuities, for instance, which have to provide expensive guarantees. The key disadvantage is that they are relatively expensive unless passive funds are used, especially where they employ single-asset managers or buy into a range of underlying single-assets-class funds, meaning two layers of management charges.

Alternatively, periodic purchases of fixed-term income annuities could provide income, leaving the remainder of the fund invested and solely focused on growth.

Drawdown offers investors full flexibility over how they withdraw from their funds. They can take regular income, occasional larger ad hoc payments, or even choose to withdraw the full fund, although investors should understand the consequences as all withdrawals are taxed as income.

While drawdown can be used by investors to provide income, it is also useful for those looking to continue growing their investments and to pass on funds on their death. The new rules mean that specific assets can be passed on to beneficiaries, without entering the investor’s estate, providing a tax-efficient solution for those with larger estates.

Paul Evans is pensions technical manager at Suffolk Life

EXPERT VIEW

Jeremy Roberts, head of UK retail sales at BlackRock, on the potential for retirees to make the wrong decision on what to do with their pension pots:

“Given the extra flexibility and the opportunity [for retirees] to take a tax-free lump sum, there is [concern over the] possibility that it will be used for short-term issues.

“Of course, it’s human nature to focus on the issues of today rather than those 10, 20 or 30 years in the future. But when we’re all living longer we have to try to focus on the longer term. It is possible that some will use that tax-free lump sum for other uses apart from longer-term savings.”