Income in Retirement

Retirement income projections

Money-purchase pension fund members, including those awarded a pension share from a final-salary pension scheme which has to be taken externally, have a wide range of choices in how to set up their retirement benefits at the time they reach retirement - with a wide range of annuities and income drawdown policies available. Members would normally be strongly advised to take independent investment advice in making such choices. This article, which is not by an authorised IFA but by an experienced actuary, is intended to be helpful particularly to individuals at the time of divorce - it provides comments on those choices and what might be reasonable in terms of considering the projected retirement income from money-purchase funds. It is presented in terms of the choices facing a 60-year-old man or woman reaching retirement now, with a fund of £100,000.

An actuary such as myself might advise on a reasonable long-term retirement income which might be expected from such a fund, making reasonable allowance for future increases in that income broadly matching inflation. In one recent case of mine, I advised an income of £3,549 a year, based on my current fair actuarial value methods and assumptions.

Present Market Annuity Rates 

Based on market annuity rates obtained recently, the fund would produce a lower income of £3,251 a year (9% less than the income projected above) if converted now into a guaranteed annuity with 3% a year increases, which might be considered to cover a reasonable part of future inflation - or a higher income of £5,066 a year from a guaranteed annuity with no increases - or a lower income of £2,689 a year from a guaranteed annuity with RPI inflation increases.

Many people consider alternatives to ordinary annuities, such as with-profits annuities. Based on a quote obtained recently, a with-profits annuity would produce a higher income of £4,930 a year (39% more than the income projected above) - allowing for a 2% a year anticipated bonus rate, which on the middle statutory projection is predicted to increase over the long term by around 3% a year.

In recent years there has been a large increase in the availability of impaired life annuities, where after individual underwriting based on a medical questionnaire (and sometimes an examination as well) an insurer will offer an annuity rate significantly enhanced above ordinary rates. I understand that in 2012 this made up almost half of annuities sold. It is of course impossible to predict in advance anyone's state of health at the time they start to draw their retirement income, but this possibility is a support for not using present market annuity rates in cases where health now or likely in future may not be good.

Drawdown Pensions

Income drawdown pensions (before the 2014 Budget see below) have a GAD-rate drawing, at a rate obtained recently, of 4.90% a year of the fund for a 60-year-old (based on gilts yields then of 2.5% a year), so an income of £4,900 (38% more than the income projected above). The income projected above assumes drawings of 72% of the GAD rate, which would allow the fund to support future increases broadly matching inflation is the underlying fund growth matches that assumed in my fair actuarial value basis of about 4.00% a year after fund expenses.

I comment that using drawdown pensions rather than present market annuity rates in projecting retirement income (specifically in divorce cases) is consistent with the case of BJ v MJ [2011] EWHC 2708 (Fam), where Mostyn J commented at paragraph [75]: "Mr Southgate argues that I should assume that W will buy an annuity with her share. I decline to make that assumption. No-one nowadays seriously would think of buying an annuity. Rather, they would likely drawdown on the pension within the prescribed GAD limits."

2014 Budget

I comment that the trend away from ordinary annuities, and therefore the case for projecting retirement incomes on a basis other than using present market annuity rates, is likely to be reinforced by the announcement in the 2014 Budget speech of wide-ranging changes to pensions legislation allowing even wider flexibility in drawing income from pension funds than is now available in drawdown pensions. However, as pensioners get older, they are more likely to prefer the security of a lifetime income from an annuity above the possibility of higher investment returns from continuing to manage their fund investments actively, so it appears appropriate to allow in income projections for the pensioner to switch from drawdown to annuity purchase at some point, possibly in their 70s.

Notes by: Geoffrey Wilson FIA, Excalibur Actuaries

31 December 2014

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