Nearly two years on from the introduction of pension freedoms, the landscape has changed dramatically, with annuities no longer the default route for generating retirement income.
But for those who do choose to have unfettered access to their whole pension pot, there are investment pitfalls and traps to navigate. Some savers approaching retirement will swot up extensively and do their homework on the various dangers, and feel comfortable about going it alone.
Those in this camp may be happy choosing their own investments, deciding on the appropriate proportion of income to withdraw from their pot and also deciding whether to take the 25 per cent tax-free lump sum all in one go or in stages.
The majority of retirees, however, are likely to find the whole landscape a cumbersome minefield, and will enlist the services of a professional to guide them through the decision-making process.
SWITCHING FROM PRE- TO POST-RETIREMENT
This could involve combining an annuity or other secure income with investments, or opting for an entirely investment-based approach.
Some may choose their local financial adviser or a specialist IFA, who may in turn outsource the investment management to a wealth manager, while others may go straight to a wealth manager.
In light of the pension freedoms, which enable retirement to be much more of a process than a one-off event, 'lifestyling' or target-date funds - typically the default option for workplace pension schemes - are looking increasingly redundant.
The way these funds are designed means they automatically de-risk an investor's portfolio ahead of the planned retirement date. Risk is progressively reduced over 10-15 years as the retirement date approaches.
The equity weighting falls, while cash and bond exposure is increased. The trouble is that these default funds were created for savers expecting to buy an annuity on retirement.
Instead of taking risk off the table altogether, Alan Beaney, investment director at wealth manager RC Brown, says a pre- to post-retirement portfolio should broadly speaking have a greater emphasis on income-producing assets.
The logic here is that the yield generated from the portfolio should be sufficiently high to cover the majority of the income required.
Most financial advisers stress that a maximum withdrawal rate of 4 per cent is sensible, and that retirees should ideally draw only the income produced by the pension investments - the natural yield - rather than stripping away capital.
But research by Morningstar is much more conservative. It concluded that the 'safe withdrawal rate' for UK pension savers is just 2.5 per cent.
TAKING RISK OFF THE TABLE
Morningstar's premise is that over any 30-year period the income payments will always be met, increasing in line with inflation. The overall capital may fall or remain intact, depending on market conditions. But the capital value will last those 30 years.
Beaney adds that even with a 30-year time horizon, it makes sense for retirees to take some risk off the table, though they should still have a healthy weighting towards growth assets.
'From my experience, those who do take money out steadily are most concerned about not being able to cope with the growth swings that come with investing in the stock market,' he says.
But the other school of thought is to do the opposite: maintain the same level of risk that was in place prior to retirement, and resist the urge to switch from growth to income-producing investments.
Rebecca Taylor, a certified financial planner and managing director at Aurea Financial Planning, makes the point that as retirement portfolios are there for the long haul, the investments chosen need to cater for the fact that people are living longer.
According to Taylor, moving a whole portfolio across to yield-producing assets is 'dangerous'.
She adds: 'By its nature, concentrating on yield distorts a portfolio considerably, concentrating investment across those tried and tested stocks paying high dividends, with some bonds and property thrown in in varying proportions.
'This creates a portfolio that is highly concentrated and therefore highly vulnerable to economic conditions and inflation.'
Whatever route chosen, a wealth manager will put retirees into a ready-made diversified portfolio, or design a bespoke version deemed appropriate for their risk tolerance.
A wide spread of assets will be held and there's likely to also be a small weighting in 'safe haven' alternatives such as gold and infrastructure.
Wealth managers also periodically rebalance the portfolio, which involves selling investments that have performed well and reinvesting the money in cheaper holdings to further reduce risk.
BUILD A BUFFER AGAINST STOCK MARKET STORMS
The trade-off in partially or fully sidelining annuities is that your capital is at risk and at the mercy of the financial markets. But wealth managers can put various safety measures into place to reduce the odds of the pot plummeting if a bear market strikes.
'We devote a lot of time to "sequencing risk", which is the risk that losses occur early in retirement and may prove difficult to recover,' says Simon Bashorun, financial planning team leader at Investec Wealth & Investment.
Bashorun says he recommends clients have a cash pot, equal to around two to three years' worth of income, to reduce the risk of simply being unlucky and retiring just before markets have a meltdown.
He adds that the strategy of reverting to income from the cash pot in volatile market conditions removes the risk of 'pound cost ravaging' - whereby a pension fund is rapidly eroded in a flat or falling market because the retiree has to draw on capital to maintain the required level of income, making it much harder for the fund to recover subsequently.
Withdrawing money when assets have fallen can do an enormous amount of damage.
Research by broker Hargreaves Lansdown shows that if a saver draws 6 per cent a year income from a pension pot that falls by 20 per cent in value in year one, before then growing by 4 per cent for the next nine years, at the end of 10 years the pot will be worth less than half its original value. In 20 years' time the pot will be exhausted.
In good years, when the post-pension portfolio returns more than the amount of money a client wants to withdraw, the cash pot can potentially be replenished. 'It is important to be flexible and have more than one pot to call on,' says Bashorun.
As a rule of thumb, Beaney ensures portfolios have around 3 to 8 per cent in cash, as well as exposure to short-dated bonds, which upon maturity can be used to top-up the portfolio's cash weighting.
INVESTING A LEGACY
One of the most common aspirations voiced by retirees who come through wealth managers' doors is the desire to leave a legacy for children or grandchildren.
Thanks to a welcome change in the pension rules, introduced as part of the freedoms in April 2015, the 55 per cent pension 'death tax' is no more.
Pension money passed on by those who die before age 75 is tax-free, while for those who die above that age, beneficiaries will have to pay income tax on any withdrawals they make. No inheritance tax is payable in either case.
Those with a defined contribution (investment-based) pension, and in a position to draw on other assets at retirement, should therefore exhaust the non-pension pots first, and leave the pension untouched for as long as possible.
But those who have a final salary or defined benefit (DB) pension and would like to leave a legacy face a dilemma.
While a spousal income is common in final salary schemes, typically only half the pot will go to the surviving spouse (and it dies with them), whereas by transferring to an investment-based pension, the entire remaining pension can be bequeathed to anyone.
Indeed, since the freedoms were ushered in, there has been a spike in demand to cash in DB schemes in order to benefit from this flexibility.
For many members, the DB pension benefits are essential and not worth giving up, particularly for those who do not have other resources to rely on in retirement, or who need the security of their DB pension income.
But for those who have other assets to help generate an income, transferring can prove worthwhile for inheritance tax planning purposes.
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