Have you seen an advert for “free” financial advice? Some financial advisers market their advice as “free” but there is a cost …
An article appeared in the FT today, which suggests that pension investors are in for a poorer retirement. According to the FT, the combined effect of falling equity markets and falls in annuity rates is worth together about 18% less in the space of one month. I’m not going to argue with the numbers, but my question is “Do pension investors who expect to buy annuities in order to secure their retirement income, stay fully invested in equities right up to the point of drawing benefits?”
This is a dangerous strategy since any fall in the equity markets could have a catastrophic effect on your lifetime income. In addition, the act of purchasing an annuity means transferring the risk of providing a lifetime income to an insurance company, and in doing so, crystallising the value of the pension fund on the day of annuity purchase. If you are unlucky enough to experience a fall in equity markets just as you retire, then this could mean a dramatically lower pension for the rest of your life.
The article suggests that pension investors have not given any thought to the way that pension benefits will be drawn, BEFORE the event, which means there has been no planning. It goes on to make reference to adopting pension drawdown as a short term option whilst waiting for equity prices to recover, which would be a short term knee-jerk reaction based upon the circumstances of the day. If you found yourself in this position, then perhaps you might make this choice but this is not a situation to relish and it is preventable.
In my world, financial planning would involve a discussion between client and financial planner well before the event of drawing pension benefits – probably at least five years beforehand. Within a financial plan, a lifetime cash flow forecast would identify the amount of money needed for retirement income and this would drive the investment decisions to be followed in the run up to retirement, the intended date of drawing benefits and the way in which benefits would be drawn (annuity purchase or pension drawdown being the two main options).
This planning gives clarity to the actions that would be followed and the reasons behind them.
If you are expecting to draw your pension fund benefits in the form of an annuity, then a decent financial planner will not be recommending that your investment strategy is held 100% in equities right up until the point of purchasing an annuity. Most likely, the strategy would involve a more cautious approach, to protect against exactly the circumstances highlighted in the article. Investment in fixed interest securities in the run up to drawing benefits will offer lower risk of loss than equities, and will also act as a hedge against falling annuity rates.
The key to making good decisions is to be prepared well before the event, and this means engaging a Certified Financial Planner to help you design a strategy. This way, you will be clear about what you are doing and why and you are less likely to be faced with last minute reaction to events beyond your control.