New rules to bring greater flexibility

This article is part of
Investing in Pensions - April 2015

From this month the new pension rules will give investors greater flexibility when accessing income and capital and lower tax liabilities when passing on unused funds.

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.

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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.