Here we look at how alternatively secured pension’s (ASP’s) are evolving, especially with a lot of talk about the need to abolish having to buy a pension annuity by age 75.

At at age 75, ASP requires a minimum income of between 65% and 90% of Government Actuary’s Department (GAD) rates, with GAD rates being restricted to those applicable for a person aged 75 even as the client gets older. 75 could be seen as a bit random nowadays when we are being encouraged to work longer and where some ability to have flexiblility with pensions exists.

For a husband with a wife who is considerably younger, or vice versa, the death of one party in ASP could see the dependant in unsecured pension (USP) and therefore with the option of a death benefit of the fund value less 35% tax. It is also important to remember that a pension annuity purchase is always an option.

If a pension annuity is seen as longevity insurance, the annuity rates get better the older that you buy, so if that annuity is not purchased until the client is in his eighties then an enhanced annuity rate might be available. It might even be possible to buy an annuity with a guarantee period built in which could guarantee a stream of income back to the deceased’s estate.

Retirement planning is going to become increasingly important. There are more and more options available to the retiree and product innovation is likely to become more important. We have already witnessed the development of third way ‘variable annuity’ products.

Here we look at the issues retirees face when tackling the impact of inflation on their pension annuity income. First, these Individuals have to strike a balance between competing factors when converting a pension into an annuity income stream. One hot topic is inflation. Inflation of just 4% will halve the value of a level annuity income in less than 17 years, a shorter period than the average retirement.

The problem is that there are so many factors: annuity rates, investment returns, an individual retiree’s future health or life expectancy, as well as the likely effect of inflation.

Taking care of Inflation is also clearly not top priority for the majority of retirees. In 2006, 87% of the 350,000 pension annuity contracts sold paid a level income for life, just 6% included escalation, with the remainder made up of impaired annuities, enhanced annuities and investment-linked contracts.

The cost of inflation-proofing is one stumbling block. A 65-year-old, non-smoking man investing a £100,000 pension pot in a single-life pension annuity guaranteed for 10 years could receive a level income of £7,692 a year from the best paying lifetime annuity provider. This is a significant £3,012 a year more than the retail price index (RPI)-linked equivalent (£4,680) starting annuity income.

An option is fixed escalation, either through a conventional lifetime annuity that pays out for life, or a fixed-rate annuity that pays a secure income for a fixed period, then matures, allowing the retiree to rethink their financial strategy according to circumstances. The 65-year-old man above could receive a starting income of £5,664 from the ‘best buy’ lifetime annuity which, rising at a fixed 3% a year, would exceed the level annuity annual income in year 12 and the overall income by year 21.

There are other options for wealthier and more financially sophisticated retirees. We have income drawdown or with-profits annuities which effectively keep funds invested in a range of assets. The hope is that positive investment performance will outweigh any negative effects from inflation.

The conclusion to this is that hedging pension income fully or even partly against inflation either means higher costs or risks, and possibly a combination of the two. Wealthier people may be alright with this, but the majority might not.

The majority of annuity purchasers still fail to exercise their open market option to shop around for the best annuity rates for their circumstances. They also lock into ‘healthy lives’ annuity rates, just at a time when the chances of succumbing to ill health are starting to increase. Even though retirement is getting longer, we are actually spending a greater proportion of those years in poor health.

If you do buy a conventional annuity you lose any income flexibility compared to unsecured pension products like income drawdown or fixed term annuities that allow you to tailor your income to meet your changing needs and state of health over the years.

If inflation falls and annuity rates start to fall back, those retirees who wait could be faced with the prospect of a lower retirement income. But, waiting before committing to an annuity could mean a  potential benefit from being able to respond to changing individual circumstances - for example, through becoming eligible for higher impaired annuity rates, future product innovation, legislative changes, or being able to extend death benefits for longer. 

There are still those in the annuity industry who think the government should scrap the rule that forces individuals to purchase an annuity or move into an alternatively secured pension (ASP) at the age of 75. One expert even suggested it was a ‘blight’ on financial planners.

Annuities are not the only option at retirement, either. Consideration should be given to variable annuities, phased retirement and income drawdown.

A variable annuity has the advantages of guaranteed income, the longevity insurance and the income for life without having to annuitise the pension fund.

So, whether the age 75 rule is changed or not there are alternatives to annuities. Take advice, see if an alternative is right for you.

Are you considering a Sipp? If you are, here’s a checklist for you to run through.

Are you in a final salary pension scheme? If so, then in nearly every case, you should stay put and not transfer.

Is your current pension invested in with-profits? If so, are there exit penalties (called market value adjustments (MVAs))?

Does your current plan offer guaranteed rates of future growth?

Is there potential for a demutualisation bonus? (Not as likely these days)

Does your current pension offer a guaranteed retirement income rate (a guaranteed annuity rate (GAR))? This is likely to offer a better annuity income than you could get in the general market.

Is your adviser properly qualified for the purpose of advising you? Better qualified advisers will have a diploma in financial planning and have taken the JO4 and JO5 exams.

Are you nearing retirement? If so, there will be less time for the new investments to overcome any new costs charged, penalties incurred or loss of guarantees.

Are you prepared for losses incurred by being out of the market during the transfer of funds? You won’t be invested in the stock market while the transfer takes place. This could protect your savings if the market falls, but means you could lose out on any gains.

Are there any transfer penalties with your existing contract?

Will you lose any tax-free lump sum entitlement? Some transfers mean that you will receive less tax-free cash at retirement.

Just some things to think about if a Sipp is on your mind.

A leading provider in the enhanced annuity arena, MGM Advantage, is  lining up a ‘third way’ product for next year. It is planning to launch a ‘third-way’ unit linked product in 2009 as part of a drive for innovation in the ever growing pension annuities space.

Their sales director Aston Goodey, previously of Prudential, said the plan would be aimed at people aged between 50 and 75, and would be linked to a pension annuity rather than an income drawdown contract. The idea is that it would be asset backed, offer some income protection and possibly some sort of capital protection. Definitely still on the drawing board ! He even likened the product to with-profits annuities.

Interestingly, they are keen to avoid any associations of the product with variable annuitiy contracts, which have so far received a pretty much lukewarm reception in the UK at-retirement market. MGM Advantage claim the market is ‘crying out’ for innovation.

So, the end result is that they are likely to launch a new annuity based contract, with flexibility, but they don’t want it badged as a variable annuity. Interesting dilemma.