Buying a decent annuity for your retirement usually means having a very hefty pension pot to draw upon. Another, often cheaper, solution is to remain invested
Here’s an alarming statistic for those of us with defined contribution pensions: if a retired couple wants to generate an income that’s on a par with the average annual take home wage, they must have a collective pension pot worth nearly a million pounds.
However, this depressing fact is only true if you buy an annuity with your pension pot – a retirement solution that is no longer compulsory for anyone. Under the annuity model Britain’s typical retired couple needs a pension pot of £955,000 – alarmingly close to a million pounds – to buy an annuity that generates the UK average income of £26,884 for each partner.
This is made worse because these annuities include no inflation protection, pass on just 50pc of the income to a surviving spouse and cannot be passed on as an inheritance to future generations.
The government’s new pension proposals mean that you can retire with an income like that, but with a much smaller pot. John Ventre, head of multi-manager at Old Mutual, says that the guaranteed nature of annuities has made them too expensive for many people who are trying to make the very most from their retirement savings.
“A more effective solution to this problem is to remain invested, an option that from April 2015 should be available to everyone,” he says. “While this may seem like a risky option, that is to ignore the real risks that today’s retirees face.”
One of the biggest risks is the effect of inflation on their portfolios. “To preserve living standards in retirement, protection from the effects of inflation is critical,” Mr Ventre says.
“For many people, the point of retirement is the point of greatest wealth; savings that have been accumulated over many years of hard work. But this wealth is illusory without protection from inflation which can eat away at the purchasing power of savings over time.”
If you assume that inflation averages out at 3pc, you would lose almost a third of the purchasing power of your savings over 10 years, and over half over 20 years. “Someone retiring today would expect to live 20 years and a 3pc inflation assumption is conservative,” Mr Ventre continues.
How can today’s retirees remain invested and retire in the same comfort as someone with a million pound pension pot buying an annuity, avoiding the risks of inflation?
“I believe that these risks are best addressed by an investment portfolio that is designed ‘from the bottom up’, rather than by repurposing existing investment strategies which are often designed to accumulate wealth rather than to live off it,” Mr Ventre says. “In arriving at an appropriate asset allocation for such a portfolio, there are two key considerations: income and inflation.
“We believe that real assets, such as infrastructure, commodities and property, can play an important role in retirement-optimised portfolios. A truly multi-asset approach can make a real difference.”
“Old Mutual Generation funds aim to provide investors with an income from their savings while growing the assets ahead of the rate of inflation over time.
“Being designed from the ground up to do this, the funds have delivered strong positive absolute returns over this period and we believe they are exactly the right kind of innovative solution to fill the annuity gap that now exists.”