There are some new figures from the Government revealing just how much Britons need to save to avoid retiring on means-tested state benefits…and it makes for a daunting read. The Department for Work and Pensions (DWP) admits that low earners will see their retirement income increase by only 1 per cent of their salary, or £2 a week, after 10 years’ saving in the Government’s flagship new pension scheme to be launched in 2012. This as a result of means testing pension income. Not a particularly good return!

These figures highlight the way Pension Credit, the means-tested benefit paid to pensioners with small pensions, reduces the incentive for many people to save. Indeed, some research suggests that the average UK saver needs to build up a pension pot of £43,789 to avoid retiring on benefits at age 65. This pension pot then being used to buy a pension annuity for the individual’s retirement income. Interestingly, the average pension pot in the UK today is below this figure, nearer £35,000.

Some say this is a hangover of offering Pension Credit to today’s pensioners, which has helped millions of elderly people, but has also had an effect on the incentive for many to save.

Many people will fall on benefits as they get older because while basic state pension rises each year in line with prices, and most pension annuities have no inflation protection at all, the threshold for benefits goes up in line with wage inflation, which increases at a higher rate.

Non-means tested state pension comes in two parts. Basic state pension, currently £90.70, and state second pension, which varies in amount depending on earnings over your working life. The average combined basic and state second pension is currently £134 a week.

To understand how the means-testing system will affect your pension saving, you need to know how much state pension you are likely to get. You can do this by contacting the Pensions Service by telephone or by visiting their website in the first instance.

Here’s a statement that’s hardly a surprise. The recent fall in property prices is not good news for those who are relying on property for their pension income in retirement.  Roughly 18% of all outstanding buy to let debt was taken out in 2007 when property prices peaked and some of these investors could now be in negative equity. They probably thought it was a good idea at the time and a better option looking ahead than a pension annuity.

Some who have been in the market for years will be fine as they will have large capital gains to cushion any downturn in prices - provided their portfolio is not over geared and they can afford rising mortgage interest payments.  Interestingly, though, one third of all landlords own just one buy to let property and if they bought recently, they could be seeing a loss on their investment. One really isn’t a good long term idea…too much reliance on one property.

For the overwhelming majority of the population, buy-to-let should not be seen as an alternative to making regular savings into a pension. 

Investors’ losses are on paper until they sell their assets and provided landlords have good tenants who pay the rent and it is sufficient to cover mortgage interest payments, the actual value of the property doesn’t matter in the short term. But the chief worry is that they may be forced to sell up because interest payments become unaffordable. 

The risks of using a buy-to-let investment as a way to save for retirement have always been there. Over the long term a buy-to-let investment should still return a healthy profit, and those who have injected a substantial amount of equity into the property should be positioned to ride out a downturn.

Mind you it’s fair to say that equity investors have suffered recently, as well as property investors. The FTSE 100 has fallen 19% from its June 2007 peak. Pension investors would therefore have lost 19% of the value of their UK equity portfolio if they had invested at the top of the market.

It is an interesting issue, and probably the best course of action, if possible, is to build up a large pension pot to be able to buy a healthy pension annuity income at retirement, but also have other means of income, such as buy to let, to top up the retirement income.

Life Trust have been working on producing a report that puts a figure on the cost of retirement. This has been done in conjunction with the Centre for Economic and Business Research, and makes interesting reading…though quite daunting. The report finding suggests that retirees need £413,000 on average to fund a retirement lasting from 65 to the average life expectancy. That’s enough for a very large pension annuity.

From the report: those in the top 20% for earnings could expect to spend £1.55m on their retirement should they live to 100. Spending on transport, recreation and culture, hotels and restaurants, and alcohol and tobacco accounts for 44% at age 65. This then falls to 26% at age 85 and 18% at age 95. The older individual does tend to spend more than others on certain things, but as they are able to do less, they spend less.

Professor Sarah Harper, Director of the Oxford Institute of Ageing, has been quoted on several occasions as saying that soon “90 will be the new 70”. But many people don’t have the disposable income to accompany their physical well-being and living longer.

As we get older, more and more of our budget is eaten up by the basic costs of living. The amount spent on fuel, housing and power increases nearly four fold during retirement going from £34 per week at age 65 to £116 at 92. Those retiring today, born and raised in the long shadow of the second world war, amidst rationing and economic deprivation, may well know a thing or two about sacrifice. 

We should be trying to ensure that people in the decumulation phase are amply provided for the whole duration, but the increase in products such as equity release in recent years reveals that it is not rare for people to run short of income. It is vitally important that we in financial services offer today’s retirees products, services and advice that can save them from foregoing indulgences in their later retirement, in the same way they did at the outset of their lives.

Some people in the industry, like Lincoln Retirement Income, believe that traditional pension annuities, with their limited choices and inflexible rules, will become a thing of the past. Today’s clients demand and deserve a much more flexible solution, to let them enjoy their retirement in their own time and on their own terms.

A new plan has been launched to reflect this, the Lincoln i2Live plan. It is a flexible retirement plan that provides with: a unique Income Guarantee Option;  investment choice, regardless of age and taking an income;  flexible death benefits for dependants;  the opportunity to select and vary income;  and consolidate pension assets all in one plan to create an overall income strategy (currently excluding Protected Rights).

There are phased retirement options, and one annual statement for all aspects of their Lincoln i2 Live income plan. They claim it is one plan with many options.

Lincoln i2Live combines three retirement planning products in one arrangement. Depending on their needs and circumstances, clients can select an individual product or allocate funds between them at no additional cost, offering control over their financial future; known as:

i2Live Accumulator®: personal pension 
i2Live Drawdown®: income drawdown
i2Live Annuity®: flexible unit-linked annuity

Another insurance company coming in with a flexible annuity product. What we really need is a major UK insurer to get their product launched to stimulate interest in the domestic market.

Here we consider the benefits of pension annuities and why income drawdown should be approached with caution. There really is no argument to suggest that income drawdown will eventually replace pension annuities, although there is a role for income drawdown and variable annuities for the right customer at the right time.

Let’s consider annuitisation. It can work within pension annuities invested in unitised funds thereby enabling a higher lifetime income in exchange for giving up capital on death. There is therefore no suggestion that income drawdown will replace pension annuities simply because drawdown can invest in equities and enjoy the benefit of the equity risk premium.

The critical difference between annuities and drawdown is the impact that annuitisation has on the trade-off between income and death benefits. Higher death benefits result in lower income and vice versa - you can’t magic something out of nothing or magic the risk away.

One major reason why drawdown will not replace annuities is the size of pension funds. Too many are too small; over 75% of current funds are less than £30,000 after the 25% tax free cash has been taken. 

Hopefully, fund sizes will increase significantly in the future and this may lead to higher drawdown take up. But there are always going to be a lot of pensioners with insufficient funds to be able to afford the drawdown route, and who will get better value from buying a new generation pension annuity product.