WHEN we imagine the lifestyle we hope for in our retirement, we tend to think of covering the household bills, running a car, perhaps taking the occasional holiday. However, there are additional costs that we perhaps fail to include, when making our financial plan.
I was reminded of that this week when I spotted a new report by American Express saying that on average we spend £857 a year on celebrating birthdays.
This includes, on average, £36.61 on a gift, and £41.33 on the birthday party itself – and those figures can rise by 50 per cent for ‘milestone’ birthdays such as 18, 21, or 50. Amex base their total figure on our having, typically, 11 birthdays to celebrate each year.
Now leaping into the future, how do we ensure that we will always be in a position to celebrate our family’s birthdays, after our working life is over? How do we ensure a steady flow of income?
Well, the traditional way to convert our pension into a regular monthly income is, of course, by purchasing an annuity.
Now, let me start out by freely conceding that many annuity rates are fairly dire at the moment. In fact, they haven’t been well since the credit crunch of 2008. The annuity market then took a further hit in 2015, when the requirement for pension savers to buy an annuity was scrapped, and the flexibility to draw down slices of our pension savings came in.
This had immediate and serious consequences for annuity sales, with some of the larger annuity providers pulling out of the market in the months since.
One high-profile provider who has substantially stepped down its annuity offering is Prudential.
Since June 17 this year, Prudential is no longer selling annuities through advisers on the open market, and now offers annuities only to its own customers. They blame the move on the decline in demand since the pension freedoms took effect.
And that’s no wonder. In fact, annual annuity incomes have fallen by around 40 per cent in the last eight years. The Association of British Insurers tells us that as a result, just one in 12 pension savers entering retirement opted for an annuity last year.
However, the road to ‘taking the money’ through drawdown is not without its pitfalls either. There are plenty of warnings going out to people opting for drawdown, urging them to be careful they are not on a crash course to running out of money in their retirement.
The current rule of thumb for drawdown is the ‘Four Percent Drawdown Rule’. This declares that if you take no more than 4 per cent of your pension savings each year, you should be OK - your pot should last you through a 30-year retirement.
However, given market volatility, some experts believe that this may well need downward revision to 3.5 per cent to be on the safe side.
The drawdown route, therefore, comes with a certain degree of uncertainty and needs careful management, as unpredictable market forces will always be in play.
Any investor worth his salt, from John Templeton to Warren Buffett, will tell you: "never try to predict the economy". Or, as the economist John Kenneth Galbraith more stylishly put it: “The only function of economic forecasting is to make astrology look respectable.”
The security of the regular, guaranteed income from an annuity is appreciated by many savers, and not just in the UK: the Swiss, famous for their probity and financial prudence, have the same pension freedoms as we do, but over 70 per cent of retiring Swiss still opt for an annuity.
And you don’t knock the nation that invented Toblerone.
As I say, in the UK you are no longer required to buy an annuity on retirement. Many 65 year-olds are choosing to take some drawdown cash right away, but plan to convert the bulk of their savings into a dependable income by buying an annuity in five or 10 years, when the current travails afflicting the market could have receded, and annuity rates might well recover.
Now that the dust has settled following the initial flurry of drawdown activity since April 2015, there is a growing perception that the annuity will never lose its attraction, because it offers what drawdown options do not - longevity protection.
We know that the whole point of retirement saving is to make sure you won’t run out of money after you stop work. Well, drawdown does not guarantee that, in the way that the humble annuity does. The annuity is a product that pools longevity risk, which is why it offers this reliability, no matter how long you live.
Of course, annuity versus drawdown is a matter of ‘horses for courses’ and what suits one person may not suit another.
It’s a complex choice, and one that is certainly worth discussing with an independent financial adviser.
What you decide is, after all, likely to define your quality of life in retirement.
And that will, hopefully, involve a lot of birthdays.
:: Michael Kennedy is an independent financial adviser and pensions specialist, and can be contacted on 028 71886005
