Retirement choices are on the increase in UK

DECIDING what to do with your pension fund at retirement used to be straightforward. You either took an annuity and locked yourself into the same income level for life, or chose to take more of a gamble with income drawdown. But in the past two years, people approaching retirement in the UK have had a new generation of products from which to choose, combining the certainty of annuities with the potential for growth offered by income drawdown.

While annuities promise a guaranteed income for life, the long-term trend for annuity rates – although presently at a five-year high – is downwards and the level of income is fixed from the outset. Income drawdown, in contrast, allows retirees with a pension fund of £50,000 or more to draw an income direct from their pension fund and defer buying an annuity, instead having the flexibility for further investment.

But with an Ernst & Young report this week revealing that a combination of increased longevity and inflation can cut retired people's spending power by as much as 40 per cent over 25 years, demand for the ability to enjoy some investment growth without risking retirement funds is set to grow.

And on Monday Aegon will launch a new variation on the idea, Income for Life. The product is a pension version of the Edinburgh-based insurer's 5 for Life unit-linked investment bond, which was launched in 2006 and pays an income of 5 per cent of your fund value for life from the age of 60.

The new version is essentially an income drawdown product but with a guaranteed income for life, accepting transfers from UK pension plans. It is aimed at those between 55 and 70 with pension funds of £50,000 or more who want to retain control of how their money is invested up to age 75.

The plan, like most in the market, is best suited to those who fall between the annuity and income drawdown stools, according to Stewart Siegel, principal of Punter Southall Financial Management in Edinburgh. "It is for people who would get an annuity but do not want the restrictions and those who would otherwise opt for income drawdown but do not want the risk posed by the underlying investments."

At its core is a guaranteed level of income, depending on when income is first taken and on whether the plan is on a single or joint-life basis. For example, if you start drawing down income from age 60 on a single-life basis the guaranteed minimum income is 5 per cent for the whole term. This rises to 6.5 per cent where the planholder is 75 when first taking income on a single-life option. There is also an escalating income feature, allowing increased income in the event of the underlying investments performing well.

While the income is guaranteed, it can fall if more than the guaranteed income level is taken in one year; if a pension-sharing order is made by a former spouse or civil partner against the plan; or if part of it is cashed in or transferred.

The investment range includes four passive and four active funds plus a cash fund, with the highest equity element just 60 per cent of the fund, at a cost of 1.6 per cent a year. "The higher the equity exposure, the higher the cost of the guarantee and for this type of product we felt there was no need for more than 60 per cent," a spokesman for Aegon explained. A guarantee charge of 0.5 per cent is also levied for the cash fund.

Tom McPhail, head of pensions research at IFA Hargreaves Lansdown, believes that for many investors the guarantee charges will reduce the appeal of the product. "I am not convinced the guarantees are worth it. Even at the cheaper end of the market it's a question of whether you are happy to pay the price of the guarantees, so investors who want a guarantee should think hard about the impact of the cost on investment growth."

But Siegel pointed out that, in the current uncertain climate, more people may be willing to pay for guarantees. "As with all things it is a balance between cost and value and although the product becomes more expensive when you take the charge into account, the price for a guarantee and flexibility is not that bad."

At age 75, retirees have the choice of buying an annuity with Aegon or on the open market, or transferring to an alternatively secured pension. The plan provides the customer's dependants with a choice of inheritance benefits based on the guarantee option selected at the outset and the value of the plan.

With around 800,000 people set to retire this year, the at- retirement market, worth some £14 billion according to Watson Wyatt, is mushrooming. "It is driven by numbers, with the baby boom generation hitting retirement, and the size of the pension pots coming into the market," said McPhail.

Mike Douglas, Aegon UK's at-retirement director, said the new product aimed to capitalise on that demand. "We believe Income for Life and other similar retirement products are likely to suit about 10 per cent of that market and we recognise the growth potential. The concept of products such as Income for Life is gaining momentum."

Similar alternatives to annuities are already available in the UK. The Hartford Platinum Plan also pays out a guaranteed income depending on age, with a 65-year-old receiving 5 per cent. Unlike the Aegon product, the plan can also be used before retirement to build up funds, although £50,000 needs to be accumulated before income can be drawn. But there is a cap of 10 per cent on any investment growth and advisers have criticised the charges on the plan, which can reach 1.94 per cent when the customer begins taking income.

Elsewhere, Lincoln Financial also has a drawdown plan with a guaranteed minimum income, while MetLife's drawdown offering promises a guaranteed fund value from shortly before the 75th birthday, with the value of the fund locked in every five years. There's also the option to withdraw up to 5 per cent of the initial investment until shortly before age 75.

"The Aegon plan is more balanced than some of the others available because the guarantee is quite simple and transparent," said McPhail. "What you see is what you get, so it depends how much premium you put on peace of mind."

Axa and Prudential are among several UK life offices set to enter the market in the coming months, while Standard Life is developing a guarantee element for use within its SIPP.