Alanna Petroff: We've all been told to save up for our retirement, and we're encouraged to save into a pension. But what happens when we are nearing the end of our working life? Joining me now to talk about this transition into retirement is Richard Parkin from Fidelity Worldwide Investment.
Richard, thanks very much for coming in.
Richard Parkin: Thanks for having me.
Petroff: Now, let's talk about how people save up ahead of retirement, and then we'll get into making that transition. So where are people saving?
Parkin: Okay. So, a lot of people will still have an element of ‘defined benefit pension’, so these are the guaranteed pensions that were very common a few years ago. But increasingly people are saving into what we call ‘defined contribution pensions’, where they and their employer will pay a regular amount in, and then they have to buy an income when they reach retirement. This type of scheme is becoming very common, and so as time goes on we’ll see this becoming a more and more important decision for people. So, as well as pensions, people will potentially have other forms of saving. They might have ISAs, or individual savings accounts. They may have money on deposit, and people need to consider all of those assets when they are thinking about their retirement income.
Petroff: So as you are nearing your retirement, or you're just about to go into retirement, what are your options at that point?
Parkin: Okay. If we just focus in on the types of product that you would use for pension savings, there’s effectively two broad product types. One is annuities, so an annuity is a contract that you buy from an insurance company, where you pay a fixed amount of money to an insurance company, and in return they pay you an income for the rest of your life usually.
Petroff: And that's a guaranteed income?
Parkin: That's a guaranteed income. Generally the payments are fixed and known in advance. You can get some features, like you can get annuities where the payments are linked to inflation, but the real benefit of an annuity is that it's a certain guaranteed level of income, and as I said, goes on for as long as you live regardless of whether that’s shorter or longer than you might expect. So, that's annuities. Annuities tend to be very useful where people need a lot of certainty around income, maybe they’ve got some fixed expenses of running the house or just living that they want to cover and these are a useful source of income there.
On the other hand, you've got a product called ‘income drawdown’, and effectively this looks like an investment account; very similar to the type of savings account that people have accumulated their pension money in. But the difference is that while staying invested, you can actually start taking income from the assets. So, the benefits of this is that you remain invested in the markets, and if you can afford to continue to take investment risk, then there is potentially some benefit in staying invested. But importantly as well, you get a lot of flexibility over the level of income you take. So it might be that you don't actually need to take all of your money as income from day one, and so converting over into an annuity might not be appropriate. But with income drawdown, you can say invested and maybe just take enough money to supplement any wages or other earnings that you've got until the point that you actually need to convert everything to income.
Petroff: But you don't have total flexibility with income drawdown, there are some rules attached to it.
Parkin: There are some rules. Generally, you can't take out a lot more than you would be able to get if you had an annuity. So the idea is that the rules stop you from cleaning your pot out before you die. But people tend to use it more because they want to take less income to start off, and then continue to stay invested.
Petroff: What would be a key tip that you want to give someone if they are approaching retirement and they're looking at the options available?
Parkin: Yeah. The most important thing is to plan ahead. We too often see people get very close to retirement, perhaps when they get their letter six months away from retirement saying they’ve got to make a decision, that’s the first they start thinking about it. We now write to our customers five years from retirement and suggest they start planning. But people should be looking at this as far out as possibly 10 years ahead. The move to retirement now is not a point in time, it's a transition over time of moving from work into retirement. So, people need to start thinking about that a long way ahead.
Petroff: Okay. Thanks very much for joining me.
Parkin: Thank you.
Petroff: That was Richard Parkin from Fidelity Worldwide Investment. I am Alanna Petroff. Thanks for watching Morningstar.