UK: Making The Most Out Of Your Retirement Funds

Last Updated: 7 February 2011
Article by Ian Luck

Could you be making your pension money work harder?

When the majority of people were members of DB pension schemes there was no need for them to worry about making the most of accumulated retirement funds, as the scheme and ultimately the sponsoring employer were responsible for delivering the promised benefit.

Today, most people have at least a proportion, if not all, of their pension built up within a DC arrangement, such as a money purchase plan or group personal pension plan. As the only promise made by the employer under such arrangements is the amount of contribution, the onus has switched to the member to try and gain the greatest possible income from those pension funds. This has lead to an ever widening range of investment opportunities as members try to maximise the growth of the fund, but one of the easiest ways of making your pension money work harder is to shop around for your annuity by taking the open market option (OMO). It is therefore somewhat disappointing to find that only 36% of people are taking the OMO at retirement. If you have never heard of the OMO, then read on.

How can the OMO help boost my pension income?

DC arrangements are vehicles which allow members to accumulate funds over the years up to their retirement through a combination of contributions and investment growth. While members have a range of options at retirement, typically they will choose to secure their income for the rest of their lives by purchasing an annuity with the accumulated funds. As members get closer to their selected retirement date the provider will issue details to them of the annuity it is prepared to offer on the funds accumulated. The process is very straightforward and many members just tick the box and take the annuity income quoted.

However, it is not necessary to secure the annuity with the provider used to build up the funds, as the vast majority of DC arrangements give members the right to take an OMO and secure the funds with an annuity provider that is offering better terms. The annuity market is just like any other, with competitive forces and financial capital requirements forcing providers to move their position. This does not just result in marginal advantages – by shopping around at retirement you could achieve an increase in income of some 25%.

Choosing an annuity

There are other issues to consider. When quoting the amount of income available from the accumulated fund the provider often includes only a single life, nonescalating pension as these will show the highest level of initial income. But what if you are married and your spouse has no private means of income? The annuity that pays a pension to your spouse in the event of your death might be worth a lower starting pension payable to you. While non-escalating annuities might be appropriate in the current low inflationary environment, should circumstances change, the buying power of your income may rapidly diminish.

The provider of the annuity and its shape are important factors to consider as it is effectively taking a gamble on your longevity. A huge part of the annuity income represents how long the provider anticipates having to pay the income to you. There has existed for a long time an impaired life annuity market providing higher annuity rates and therefore greater income for those individuals where life expectancy is reduced. For example, if at retirement you are in poor health having previously suffered a heart attack the expectation is that your death will occur earlier than someone in full health. It is likely that the benefits will be paid out for a shorter period and market conditions mean that providers specialising in this market can offer higher rates than those that do not.

As better and more complete data becomes available about the effects that other medical treatment and lifestyle choices have on longevity a few providers have entered the market offering what are known as enhanced annuities. These can often be provided based upon smoking and alcohol intake as well as reliance upon prescription drugs. It has been anticipated that perhaps up to 65% of people taking out annuities might be entitled to an enhanced annuity.

Next steps

So, even at the point of taking the benefits it is potentially not too late to make significant improvements to many people's income, but how should they go about obtaining them? It is possible to find this information online, but we would recommend that the first search that anyone does is for an independent adviser who can help you through the myriad of options that exist, and preferably one that offers a dedicated annuity service.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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