Jenny Lowe weighs up the potential for pension products with unit-linked guarantees in the current market climate.

If we can learn anything from the 2008/09 market crash, it’s that the years prior to retirement are the most crucial.
Savers who suffer 20 per cent falls in the value of their pension fund in the five years before retirement face having to triple their contributions to stay on track.

A person saving £500 a month for 25 years can generate a pension pot of £407,000, according to insurer MetLife. However, if the value of that fund falls 20 per cent just five years before the saver reaches retirement, they would have to increase their pension contributions by an extra £1,031 a month to meet the same savings target.

Timing and good financial planning advice is the key. If, for instance, the same 20 per cent drop had occurred during the first five years of their pension saving, their monthly contributions would need to rise by only an extra £55.51.

So what can be done to prevent this happening? Well, MetLife recommends unit-linked guarantees as a precaution against drops in the value of pension savings. These vehicles provide a guaranteed pension income which cannot fall below a certain level.

Growth potential

What makes unit-linked guarantees so interesting is that they are options on well-known unit-linked savings products – such as investment bonds or income drawdown pension policies – and offer growth potential, flexibility and the possibility of lump sum legacy benefits.

The guarantees can take various forms, the most popular being minimum income guarantees, either for life or for a limited term, and maturity guarantees.

The investor can continue to choose a diversified portfolio of investments with the benefit of growth potential and the flexibility to take a cash-in value or a transfer value if they so wish.

These guarantees may increase if fund performance is good. In return for the guarantee, the investor pays an additional annual charge from their fund.

Income or maturity payments are paid out of the fund. But in the event that the fund is not sufficient – say if stock market returns have been poor or if the individual lives to a ripe old age – then the insurer will step in and ensure that the guaranteed payments are honoured.

Unit-linked guarantees are a relatively new concept in the UK market but offer the possibility to combine unit-linked investment with insurance against the worst outcomes.

The insurance approach can also give those saving for retirement an opportunity to lock in gains periodically after a rise in the stock market.

For example, if a pension fund is worth £50,000 today, the insurer would guarantee that the fund value will not fall below £50,000 in future.

However, research from Aegon suggests people don’t know they can also insure their retirement income, but once made aware of the option, 49 per cent of people who have yet to retire say they would consider it.

The price of protection

Of course, guarantees do come at a price. The price of providing guarantees is often cited as one of the biggest consumer concerns with guaranteed products in the UK. Investors must consider not only the annual management charge (AMC), but also any administration or fund charges and/or charges for the guarantees themselves. These vary from provider to provider and are based on the options chosen by the investor.

Sharp falls suffered by equity markets during 2008/09 may have led you to think that equities have significant upside potential. If you are convinced that the stock market has to go up and cannot fall much, then you may feel confident enough to take the risk and wait for it to work for you.

However, if you are not totally sure or simply cannot afford to get it wrong, then you may want to consider a solution such as this. In reality, there are no guarantees that the stock market will rise strongly. If the economy fails to recover, or the UK experiences a repeat of the Japanese experience, there could also be much more downside risk even from current levels.

This means that you may be partial to keeping your money in the stock market, but you may also wish to consider these protected products.