Which way should you go in retirement?

Which way should you go in retirement?

It's time to retire, and you might think you have done all the hard work in building up your pension pot. But converting your nest-egg into income will be the most crucial financial decision of your life. The traditional way is to use the capital to buy an annuity - an annual income from an insurance company. The rate of income paid by annuities has been on a long downwards slope, but rising interest rates mean there are signs of improvement.

Peter Magliocco, associate regional director at specialist adviser the Annuity Bureau, says: 'Retirees are beginning to see the benefit of higher interest rates, with annuity rates rising strongly since the start of the year. With speculation about further increases in the base rate, we expect people on the verge of retiring to benefit further as the year progresses.'

But if you hate the idea of buying an annuity, there are ways of delaying purchase in the hope that rates will improve or, if you suffer ill health, that you will get enhanced rates later on.

Unsecured pensions

Also known as income drawdown or pension fund withdrawal, these let you draw an income directly from your pension fund while the fund remains invested. The maximum level of income you can draw is about 120 per cent of the level lifetime annuity payable to a single person of your age and sex; the minimum is zero. You can use your remaining fund to buy a lifetime annuity at any time.

Anyone in a personal.....continued below

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or stakeholder scheme can use an unsecured pension, apart from those with very small funds. If you want an unsecured pension but your employer's scheme doesn't offer it, you can transfer your pension rights from that scheme into a personal pension scheme. However, you may lose any entitlement to a tax-free cash sum greater than 25 per cent of the fund value.

Staggered vesting

Also known as phased retirement, this is a way of drawing an income from your pension fund while delaying the purchase of an annuity. Personal pensions are broken into 1,000 segments, allowing you to take benefits from segments in stages over a number of years. Each time you draw on a segment, a tax-free lump sum of 25 per cent can be taken and the balance used to buy an annuity. The remaining funds stay invested, and, hopefully, will grow to beat inflation.

This can be a useful financial planning tool if, for example, you want to ease back gradually on work and start to replace your earnings with pension income. The danger is that taking withdrawals may erode the capital value of your fund and result in a lower income in the future.

With both of these you need a careful investment strategy. Those who are overcautious might not achieve enough growth to maintain their income. Equities probably need to play a part in your portfolio.

The middle way

Guaranteed drawdown plans from US financial services firm Hartford are now available to UK pensioners. Whereas annuities offer protected income with little growth potential, and full drawdown offers opportunity for investment growth with no protection, Hartford's 'third way' aims to combine both advantages.