Age-old rules governing how pensioners can best produce a retirement income are being torn up as stocks plummet, interest rates soar and economists warn of sharp house price falls.
Savers approaching retirement and those already in “drawdown” accounts need to urgently rethink their strategy, financial advisers have said.
For a start, annuities are back in fashion. Few of these contracts, which pay a guaranteed income for life, are sold any more – but rates are soaring, hitting a 14-year high this week, said Gary Smith of Evelyn Partners, a wealth manager.
A 65-year-old buying a single-life annuity with £100,000 can now secure an income of £6,773, up by £2,352 since the start of 2022, according to provider Canada Life.
The sudden increase is thanks to a rout in the bond market, which sent government yields to historic highs. Annuities are priced off gilt yields.
Mr Smith said: “Annuities are set to make a comeback as part of the retirement planning toolkit. They have become a much more attractive option, particularly for those who value the security of the guaranteed income they offer.”
However, retirees must pay a premium if they want an annuity income that grows in line with inflation. “Index-linked” annuities promise to do so, but their higher price tag means that they would only generate the same total level of income if inflation averaged 6pc over the next 20 years, according to the Retirement Planning Project, a financial advice firm.
Pension drawdown – keeping savings invested in the stock market and gradually drawing income from it – has become the de facto strategy over the past decade, driven by the “pension freedom” reforms and strong stock market returns.
But this too has been turned on its head by volatility this year. More than a million workers have cut their pension contributions, according to research from the insurer LV, as worried savers ran to the safe haven of cash (despite ruinous inflation) rather than the stock market.
However, experts have said that even with stock markets in decline, drawdown remained the safer option for most retirees.
A 65-year-old with a £500,000 pension who used their whole pot to buy an annuity would get a yearly flat income of £36,456 a year, according to calculations from the wealth manager RBC Brewin Dolphin. But by investing they could take the same initial income and increase withdrawals by 2pc (to account for inflation) every year until the pot would run out at age 84.
Brewin’s Lee Clark said: “There are very few instances in which we would recommend an annuity. There is no protection over your income, so over the course of several decades the purchasing power of that £36,456 would be eroded. Whereas if your capital grows by 5pc per year with a drawdown approach, the income you take may remain sustainable over the long term.”
Mr Clark added that when it came to passing wealth to family members, drawdown was the clear winner. Annuities stop paying out on the death of the holder (or their partner if it is a “joint-life” contract) but money left in a pension passes on free of inheritance tax and, potentially, income tax.
But staying invested in the market has become psychologically difficult as share prices tumble. The global stock market has dropped 6pc since the start of the year.
Meanwhile, saving rates have improved. The average rate for a one-year fixed bond was 0.8pc at the start of the year, according to the analyst Moneyfacts. This means a saver with a £500,000 lump sum would have earned almost £3,000 in interest by the end of September. That is far superior to the performance of the stock market this year, where £500,000 would have instead lost close to £48,000.
Savers approaching retirement may feel less confident in taking risk on the stock market when money invested in property also looks increasingly unstable. Buy-to-let mortgages are being withdrawn from sale and interest rates on equity release loans, which allow cash to be withdrawn from property, have climbed steeply.
Andy Wilson, a financial adviser, said: “With increases of one percentage point or more, this will add £1,000 a year to a £100,000 release of money, which will be further compounded as time goes by. Falling house prices could also affect how much lenders are willing to let homeowners withdraw.”
Clive Bolton of the LV warned that many of the estimated six million pensioners who retired earlier than planned might have to return to the workforce.
Mr Bolton added: “People retiring early have less time to save into a pension fund and their fund needs to last longer. They will need to accept they potentially will have a reduced retirement income and run a greater risk of running out of money in retirement.”