Retirement has become a journey

For something that used to be a fairly straightforward transaction, buying an annuity has now become far more complex - there are thousands of options to choose from, and many variations of product type.

It is all dependent on the client's financial situation, what type of investment they have, how they see their retirement panning out and what kind of family commitments they have.

One of the biggest changes when planning clients' retirement income is the fact that it is now an ongoing journey.

When retirement meant buying an annuity and living off that, in the pre-pension freedom days, it was simply treated as a one-off event.

Value of annuities

This was one of the biggest criticisms of annuitisation - which was the main option for most people - that one's circumstances might change.

Clients may have bought an annuity and be taking an income from that, but during the course of their later life there was nothing that they could do about it financially if they required a different set of finances.

In the immediate aftermath of pension freedoms, many people rejected the concept of annuities completely, embracing the new-found freedom and ability to access all sorts of interesting drawdown products.

If you're moving from accumulation to decumulation, the issue is sequence of returns risk.Vince Hughes-Smith, Prudential

But sentiment has come full circle and now people are starting to realise that annuities have a value, especially when markets are volatile.

Vince Hughes-Smith, head of business development at Prudential, says: "If you're moving from accumulation to decumulation, the issue is sequence of returns risk.

"If you're taking an income from a given fund, let's say you invest all your money in Japanese equities because they have higher growth potential. If you're deriving an income, you are crystallising your loss in deriving that income.

"If the funds drop 30 per cent, and the pot falls from £100,000 to £70,000, and you're taking an income from that, you're crystallising a loss on that."

He continues: "The way that drawdown works, if you're taking an income from that portfolio, it makes it much harder to catch up, because you've got to recover the missing 30 per cent.

"This is a risk that is specific to people who are in drawdown."

Blending

It is for this reason that many people are using a blended solution - a mixture of annuities and drawdown. 

Mr Hughes-Smith says: "I think the critical question is: what's the base level of income you need to pay your bills?

"You have a couple who are saying [it is] £1,500 a month. You don't want to take any risk to that £1,500 a month. You can see what the additional spending is that you would like to be able to take, and you can find a means to do that.

"You may want to start the first part with your annuity, and the second part you might want to take as drawdown - the 'nice-to-have'."

"The adviser would break that down to specific levels - it's making sure that's covered," he adds.

The client is likely to have access to the state pension as well, so that will be factored into the available sources of finance.

The other advantage with annuities is that if someone is in poor health, then they can get a better rate.

Billy Burrows, retirement director at Better Retirement Group, believes that planning for retirement means financial advisers need to engage in "holistic financial planning".

In his guide, 'Retirement is a journey, not an event', he says: "Holistic planning is important but many people compartmentalise their savings and investments.

"Left to their own devices, they will deal with their pensions, investments and estate planning separately.

"Whilst this may be understandable from a behavioural finance perspective, it does not make financial planning sense because all aspects of an individual's personal finances are interlinked.

"In most cases the outcome from a series of independent and unrelated transactions is probably not as beneficial as a series of related decisions which are part of a properly constructed financial plan."

Where does DB come in?

Retirement income planning has become more complicated in the past couple of years because of the rise in the number of defined benefit transfers.

The starting point for many advisers will be the Financial Conduct Authority's position that a DB transfer will normally be unsuitable.

But this does not mean it will be unsuitable for everyone, and the rules state that those with a DB pension of more than £30,000 must seek advice from a pension transfer specialist.

For example, if the DB member is unmarried and does not have financial dependents, or they are in very poor health with significant shortened life expectancy, then a transfer may be appropriate.

Conversely, if the client wants a secure income without undue risks, or is reliant on the scheme for core income and is generally risk averse, then a DB transfer will be unsuitable.

This guide will attempt to set out some of the issues relating to retirement income.

It will look at both the starting point - asking, how does someone effectively build up a good pension pot? - then at decumulation, when making the best choices to ensure the client's pension lasts the rest of their life is critical, and then how this is managed to achieve the best returns.

melanie.tringham@ft.com