Why are guarantees an attractive option in the current market?

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For retirees, knowing what’s coming into their bank account each month is even more important than when they were in full-time work.

Till death us do part

In the past, securing retirement income was easy. A final salary pension or annuity product would pay a guaranteed regular income to the policyholder for the rest of their lives.

Annuities offer a saver a guaranteed income for the rest of their life. However, their pricing is based upon UK government bonds – or gilts – and these have produced low returns in recent years, resulting in historically low annuity rates.

As a result, more individuals are choosing an income drawdown option, particularly since the advent of the freedom of choice reforms in April 2015. But drawdown isn’t going to be the ideal solution for every client.

The freedom and choice reforms introduced by former Chancellor George Osborne have provided savers with unprecedented levels of choice, allowing full access from age 55 to spend or to pass on as a legacy. But with those choices comes responsibility.

If money is taken out of a pension, it will need to be invested somewhere until it’s spent. Investment markets have been highly volatile since the start of the new century and in recent years have reacted in extreme ways. Of course, the money put into a pension is also subject to market volatility and the value can go down as well as up.

Income drawdown/withdrawal enables investors to remain invested and take a regular income. However, some retirees are reluctant to leave all of their retirement savings invested in the stock market. There’s been a lot of volatility recently and who knows where the markets will go next. They want to have a secure annual income.

It’s all about the risk

Even if an individual’s risk tolerance and appetite indicates that drawdown is a suitable choice for them, many will opt for the security of an annuity.

It’s not a straight forward choice for those opting for drawdown, either, as if there’s one thing the markets have demonstrated since the financial crash of 2008, it’s that there are no sure-fire bets or safe havens any more.

Holding cash is impractical for an investor as you can’t currently get rates of interest to keep pace with inflation. So savers need an alternative means of securing their retirement income.

In order to assess this, advisers will have to focus not on an individual’s attitude to risk but on their capacity for loss.

The FCA has described capacity for loss as “the customers ability to absorb falls in the value of their investment. If any loss of capital would have a materially detrimental effect on their standard of living, this should be taken into account in assessing the risk that they are able to take.”

Once you understand their capacity for loss, you can have a far better understanding of attitude to risk. This will help advisers be more flexible in building a solution that will deliver retirement income in a way the client is comfortable with.

That may mean blending annuity to provide security there’s enough money to cover day to day living expenses and drawdown to deliver investment returns.

Alternatively, they may look to a new breed of products such as Aegons Secure Retirement Income (SRI) that gives the saver greater control over how they access their pension money while protecting their income from the rollercoaster of investing in the stock market.

SRI uses the fund to provide a guaranteed annual income for life but allows the saver to remain invested for potential investment growth.

And there’s more

In addition to a regular income, if the fund performs well, the savers income could rise. Every year this is reviewed and looks at 12 values throughout the year, locking in the highest fund value recorded, which would increase their income.

This means Secure Retirement Income not only protects against a falling market, it locks in the benefits from a rising one

Savers can still draw additional lump sums from their fund and the guaranteed amounts will be adjusted accordingly. Alternatively, you have the flexibility whether to provide a pension for a spouse after you die, or even pass on the fund to a loved one.

Lifelong income

Most people underestimate how long they will live presenting a very real danger that a client can outlive your savings. As you get older, the security of a guaranteed income is a great comfort.

Products like Secure Retirement Income liberate those clients from the uncertainty of an unsecured income by blending the flexibility and potential upside of drawdown with the security and protection against volatile markets of an annuity.