Retirement options were quite simple and straightforward up until relatively recently. If you were fortunate enough to be a member of a pension scheme or have your own personal pension arrangements, you either received a pension as a proportion of your final salary from a defined benefit scheme or you bought an annuity with your pension pot and that paid you a fixed income for life.
The situation is a lot more complex now. The defined benefit model has become unsustainable due to a variety of factors, and those schemes have been closing with increasing frequency. Members of defined contribution schemes as well as individuals with their own arrangements now have the option of investing in an Approved Retirement Fund (ARF).
This means that people are having to invest in risk assets for a lot longer than they thought they might if they are to enjoy a reasonable income in retirement. And this poses its own challenges.
"There are likely to be multiple options for your pension savings at retirement," says Mercer Financial Services chief executive Trevor Booth. "These usually include continued investing through an ARF, purchase a guaranteed retirement income through an annuity or taking a retirement lump sum. Taking advice at retirement is a must. There are different types of ARF and annuity, and the costs, terms and features differ from provider to provider. Independent advice will help you to get the best deal and the option most suitable for your circumstances. You should always enquire about the adviser's fees upfront."
The move into an ARF has particular implications for pension fund investment strategy and this too requires professional advice, according to Investec head of retirement and financial planning Joe Hanrahan. Many pension funds employ what are known as lifestyle investment strategies which see them moving from accumulation to protection in the years running up to the retirement date. This is achieved through a switch out of equities and other risk assets and into cash and bonds which are more secure.
“This move from risk to no risk is wrong in circumstances where you are likely to be investing in risk assets for the rest of your life,” Hanrahan argues. “There has been more pensions legislation in the past 17 years than in the previous 100. A lot of individuals in defined benefit schemes that are closing will be offered transfer values and will have no choice but to move into defined contribution arrangements. They will have to swap a guaranteed income for a variable investment return and they have never thought about this before. They are not prepared for it and they need advice to help them make the right decisions.”
He also points to a gender issue which is emerging. With an annuity or defined benefit pension there were specific arrangements in place, or not as the case may be, for a continuing pension for a surviving spouse. This is not the case with an ARF. The investment pot simply passes on to the spouse or other heirs.
“In the majority of cases men have been making all the investment decisions and they are actuarially more likely to die before their wives,” Hanrahan notes. “This could leave a surviving spouse in the position of having to deal with financial decisions of which they have no experience. People should prepare for this in advance by both spouses taking advice.”
Maiyuresh Rajah of State Street Global Advisors believes everyone could benefit from financial advice but says that affordability is an issue. “It is well known that the financial literacy level of people across the world is such that most of them are not capable of making complex financial decisions,” he says. “But the cost of advice can be prohibitive for pension scheme members. We need to get to a position where it’s cost effective for members to use.”
One solution before retirement is to ensure that pension scheme investment strategies are fit for purpose. “The vast majority of members in a defined benefit scheme will be placed in the default strategy,” says Rajah. “That makes it very important to get the default strategy right. The other strategy options are less important as only a handful of members tend to go for them.”
Post-retirement is a different issue. “People are living longer now and they don’t want to hand their money over to an insurance company for an annuity. But they have to make their ARF investment last longer. Generally speaking, most people are not capable of making those decisions on their own and they will need advice.”
Another issue which some very fortunate people may require advice on is the personal funding threshold. This is the €2 million limit which the government has place on the value of an individual’s pension fund. “This is what I call a first-world problem,” says Hanrahan. “If people hit the €2 million fund threshold there is a punitive exit tax of around 70 per cent on the amount in excess. But I just say to people that they’ve got a €2 million pension fund so why are they worrying?”