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Traditional ways to generate retirement income

This article is part of
Guide to Boosting Retirement Income

State pension

Alistair McQueen, head of policy and compliance business protection at Aviva, says the UK has one of the oldest, yet most complex, state pension systems in the world. Recognising this complexity, the government is introducing a new single-tier state pension in 2016.

This will provide a maximum income of around £150 per week, which Mr McQueen says creates a clear and ongoing foundation on which all additional saving and retirement income can be built.

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Final salary

For a fortunate few, he says a final salary pension scheme has been the other valuable source of retirement income. Around half of those retiring this year have a final salary entitlement of some form, but numbers will fall as few schemes outside the public sector are taking on new members.

As the label suggests, Mr McQueen says if a client has saved in a final salary workplace pension scheme their retirement income from this source will normally be a percentage of their final workplace salary, and will pay for the rest of their life.

He says the risk and responsibility to pay this payment sits with the sponsor of the workplace pension – normally the employer – not with the individual.

Money purchase

Increasingly most of the employed part of the nation in recent years has found themselves with a money purchase, or defined contribution, pension.

At retirement with these schemes, the amount that has been saved in this money purchase or defined contribution pension can then be converted into an income.

James McLeod, head of pensions at AES International, says for those who have defined contribution pension arrangements in addition to state benefit the choice has been between securing a pension using an annuity or taking a greater degree of risk, in particular so far as ongoing investment is concerned, by going into drawdown.

Annuity

An annuity has traditionally been the dominant form of generating a retirement income.

Aviva’s Mr McQueen says an annuity allows the saver to hand over their pension fund to an annuity provider, and in return the annuity provider will pay the saver a guaranteed income for the rest of their life.

He says: “A strong attraction of the annuity is the certainty it brings. For as long as the client lives, the annuity will keep paying. This payment is unaffected by what is happening elsewhere in the economy.”

Of course, most annuities also don’t take account of what happens with inflation so the income stream loses value. Policies that are index-linked tend to offer lower rates and most won’t pay out the amount invested for 20 or more years; rates have been in the decline across the board, too.

Mr McQueen adds: “A potential downside of annuities is that, if the annuitant changes their mind, they don’t currently have the ability to get their money back once it has been handed over to their annuity provider.