How do you convert your lifetime savings into an income when you retire? Teri Harman looks at how to use your assets

IF YOU’RE getting close to retirement, you’ve hope- fully accumulated some savings along the way. More than half of us expect to rely on our savings to supplement our State pensions, according to recent research by SHIP (Safe Home Income Plans), but many people have no concept of the best way to do this.

“People have no idea how to use their assets to execute their retirement plan,” says Rachel Vahey, head of pensions development at Aegon. “They know how to accumulate savings, but not how to ‘decumulate’. Moreover, even though people save with the express intention of using that money for their retirement, our recent research found when the time comes, there is a real reluctance to break into it.”

Retirement planning increasingly requires a long- term view. If you are retiring at 65, men can expect, on average, to live for another 17.5 years and women another 20.17, but there is a good chance you will live much longer. The Office for National Statistics (ONS) predicts that by 2033 the number of people in the UK over 90 will have trebled, the number over 95 quadrupled and there will be 80,000 centenarians, compared with 11,000 in 2008.

Changing needs

Received wisdom is that you are likely to need a higher income in the early years of retirement when you are most fit and active, perhaps with ambitions to travel abroad, hobbies to pursue, a family-sized home and one, or even two, cars to run. In later years you may be less able or inclined to travel, have downsized to a smaller more suitable property and given up your car.

However, over time, inflation is likely to rear its ugly head and you may find you incur large expenses if in later years you require long-term care or help to enable you to stay in your own home and you do not qualify for State funding.

Andrew Tully, senior pensions policy manager at Standard Life, says: “We talk about the ‘retirement smile’ meaning in the early years of retirement you need a higher income, that then tails off in your seventies, but increases again later, so much so we estimate that, should you live that long, 92 is the most expensive year of retirement.

Rachel Vahey adds: “You have to be brave enough in retirement planning to face up to the two major risks, inflation and longevity. That means looking at investments and annuities that will keep pace with price rises and accepting that, like an increasing number of elderly people, you may eventually need long-term care.”

It is important, therefore, to build some flexibility into your financial planning at retirement, so that you can access money when you need it.

Annuities

If you have saved in a money purchase (defined contribution) company pension, or have any kind of personal pension, you will have to buy an annuity with the money. Annuity rates have been falling in the wake of improved mortality and lower investment returns, making it even more important to use the ‘open market option’ to shop around for the best rate.

An estimated 90 per cent of annuitants opt for a level annuity – one that provides a fixed rather than an escalating income. Billy Burrows of annuity specialist Burrows & Cummins says: “At retirement, most people are attracted to a level annuity rather than one linked to the Retail Prices Index (RPI) because the starting income is some 40 per cent higher and it would take more than 17 years for the RPI annuity to reach the level annuity”.

This may be sensible if you have other pensions or investments that do promise to keep pace with inflation, but Mr Burrows says: “Just because RPI annuities are very expensive, it does not follow that investors should shun them or avoid protecting their pension income from the effects of inflation, especially when the spending power of a level annuity is halved in just over 20 years if inflation averages 3.5 per cent.”

Also, don’t assume all annuities are the same; the difference between the best and worst providers is as much as 34 per cent. The difference between a standard and an ‘enhanced’ annuity, for which those with health problems and/or who smoke qualify, is around 22 per cent. Consulting an independent financial adviser, such as Annuity Direct or Hargreaves Lansdown, should ensure you get the best possible deal.

Specialist IFAs will also be able to advise you whether some of the more sophisticated options, such as income drawdown (where you defer your annuity purchase and take an income from your pension fund instead) or phased retirement (where you buy a series of smaller annuities), are suitable for your circumstances.

Other savings

At any age it’s a good idea to have cash in an easily accessible ‘emergency fund’ but it is especially important when you are no longer earning. There are no hard and fast rules about how much you should keep in it, and it is unlikely to earn much interest at present, but for working people experts recommend between three and six months’ earnings.

You may also want to keep some of your capital in a higher-interest savings account, perhaps if you are planning on spending it on holidays or consumer goods. It’s not easy to find an account that pays decent interest these days, but if you are prepared to accept a notice of 120 days, Secure Trust Bank is paying 3.25 per cent on balances over £1000 and Turkish Bank (UK) 3 per cent with a 60-day notice period.

Cash Isas (Individual Savings Accounts) pay interest free of tax and you can invest up to £5100 each year, but beware that if you put in the maximum, although you can withdraw your money, you cannot reinvest it in the same tax year.

If you want to use your savings to produce income, there are a number of options, depending on your attitude to risk. If you want to ensure your capital is safe, and you can get your money out without penalty at any time, National Savings & Investments (NS&I) offers income bonds, but the interest rate is just 1.7 per cent gross on investments up to £25,000 and 2 per cent above that, meaning an investment of £20,000 would give you a paltry £28.33 a month before tax, which barely covers the cost of a daily newspaper. This underlines just how detrimental low interest rates are for savers.

A guaranteed income bond from an insurance company will also give you full capital protection, but you do need to tie your money up for a set term, usually between one and ten years. The amount of income you will receive does not alter during the ‘life’ of the bond.

If you are prepared to take a risk with your capital, distribution or high income bonds might be worth considering. Equity income funds that invest in shares of large companies with good track records for dividends, or bond funds that invest in gilts and corporate bonds, are also an option.

Professional advice

Rachel Vahey says: “People need to build a lifelong financial capability to enable

them to make hard decisions on retirement.” She suggests more could be done to develop online research tools. However, few people have the confidence to act, and this often leads to paralysis.

The logical answer is to seek professional help, but there seems to be a general mistrust of financial advisers. Finding an experienced, empathetic IFA is vital.