How to cover the costs of a long life

Experts are urging anyone turning their pension funds into retirement income to explore all options, amid fears that too many are locking into poor-value lifetime annuities that provide no protection against inflation.

They say most people opt for annuities that pay a level income throughout retirement and are ignoring better alternatives that allow it to grow.

Billy Burrows, one of the UK’s top pension annuity experts, is leading the charge to ensure more people think ‘outside the conventional annuity box’.

He is extremely concerned people are not being encouraged to think long term when deciding what to do with their pension pot. ‘Most of us will live for between 20 and 25 years in retirement, some even longer,’ he says.

‘On that basis we need to think about how best to protect our retirement income against the ravages of inflation. The solutions all involve risk, but for some they are worth taking.’

Until recently, a majority of those with defined contribution pots opted for the annuity offered them by the manager of their fund usually an insurance company. Typically, this was set up on a single-life basis with income payments staying the same throughout retirement.

But new rules introduced by the Association of British Insurers encourage everyone to shop around for a higher-paying annuity using the open market option.

They also alert retirees to the importance of providing protection to loved ones through buying a spouse’s pension and the availability of annuities that pay higher income because of poor health or a history of drinking or smoking. Although these rules will help people to make better retirement income choices, Burrows, who works for London-based retirement income specialist Better Retirement, believes they do not go far enough.

‘Shopping around for the best-paying annuity is just the tip of the iceberg,’ he says.

‘We need to get people out of the mind-set that drives them to look for the highest starting income when a better approach would be to consider other options that provide a high starting income but with the potential for future income growth.’

Alternatives to conventional level annuities include those where payments rise in line with inflation or a set amount per year. These remain unpopular because of the low starting income, although they can prove a winner if you live longer than 15 years after retirement.

Investment-linked annuities are also an option. Offered by insurance companies, they give retirees the opportunity to benefit from growing income.

However, this is not guaranteed and depends on the underlying investments performing well. Indeed, income can fall.

Other unconventional options include income drawdown and fixed-term annuities.

Burrows says that anyone who is considering these riskier options must observe three golden rules.

‘They should only consider them if they have other sources of guaranteed income,’ he says.

‘They also need to understand the risks involved and that income may fall as well as rise.

‘Finally, they have to be aware of all options. Provided they do this, they should end up making the right choice.’