Market rally shores up retirement income

Rising stock markets are giving some investors near retirement age the chance to lock into recent gains – and avoid having to delay their pensions – say advisers.

Many retirees have been opting to live on cash held in bank accounts, rather than using their pension funds to buy an annuity, in order to give their depleted funds time to recover. Others have been phasing the withdrawal of funds from their pensions, only moving a small amount at a time into drawdown and leaving the rest invested in the stock market.

Now, this wait-and-see approach may finally be paying off. Assets in defined contribution company pension schemes have risen in value by 10 per cent over the past month, said Aon Consulting this week, driven by rallying equity markets.

So financial advisers suggest that, with further stock market rises looking uncertain in the short term, this may be a good time for people to buy an annuity with their pension.

“As we see markets recover somewhat, I think we’ll see people use that as an opportunity to lock into the higher value [of their pension],” says Lee Smythe at Killik Chartered Financial Planners.

Investors who do not want to hand over their funds to an insurance company yet – preferring to keep them invested – can move some or all of their pension into income drawdown. This allows them to take out a 25 per cent tax- free lump sum to supplement income or pay off a mortgage. Or, investors can buy an annuity with the higher value of their fund, which could ensure them a higher income for life.

However, the calculation is not so simple. Aon points out that defined contribution pension funds would still have to rise in value by a further 32 per cent to return to their September 2007 levels. And investors also have to contend with falling annuity rates, as the government’s policy of quantitative easing has reduced gilt yields, which are used to determine annuity payouts.

Experts admit that anyone retiring right now is taking a bit of a gamble. “Members have got difficult decisions to make if they’re approaching retirement now,” says Helen Dowsey of Aon Consulting. “We don’t know how long the markets will take to recover and what will happen with annuity rates.”

Rather than risk keeping a pension fund heavily exposed to share prices, Dowsey suggests that investors close to retirement should be protecting their pensions by moving from riskier assets, such as global equities, into fixed interest and cash.

Often, a company scheme will carry out this asset re-allocation automatically for its members – a feature known as “lifestyling”.

The benefits of this approach are clear. Aon calculates that a 65-year-old man, with a fund of £100,000 in September 2007 fully invested in equities, has seen his total pension rise by 3.7 per cent over the last month. He can now expect to receive £4,755 a year compared with £4,586 in March 2009. This is still 40 per cent less than in September 2007 when he could have received an annual pension of £7,536. A 65-year-old invested in cash and gilts would have experienced less volatility over the past 19 months, but would have still benefited, with a total annual pension now paying £7,377 compared with £7,536 in September 2007.

This means, says Dowsey, that for the majority of people near retirement, equity market performance is largely irrelevant. If annuity rates worsen, the value of their fixed-interest investments should rise to compensate for that.

But for those invested more heavily in equities, it may be better to buy an annuity sooner rather than later. “For a lot of people, it’s better to take the pension sooner rather than delay, unless you’re invested in a way that could benefit from a significant market rally and you’re happy taking that risk so close to your retirement date,” notes Smythe.