The changing role of retirement annuities
Pension reforms introduced in April 2015 have changed the way we access our retirement savings. Now, thanks to greater freedom and choice, it's no longer necessary to purchase an annuity. But is this new found freedom working how it should?
The Financial Conduct Authority's (FCA) Retirement Outcomes Review interim report, published in July 2017, found that the most popular option for accessing a pension was to fully withdraw the pot and to do so early i.e. between ages 55 and 59.
Fall of annuities
Drawdown has become much more popular, with sales increasing eight-fold from just 5,000 in each quarter of 2013 to more than 40,000 in the third quarter of 2016, according to the FCA report. This means that twice as many pension pots are going into drawdown than being exchanged for an annuity.
But the report also raised concerns about the choices being made. Many people are making choices without advice, withdrawing cash and investing it in less tax efficient vehicles than a pension, and according to evidence to the Parliamentary Sub Committee frittering it away on gambling and alcohol.
Those who take advice realise that making the pension pot last a lifetime takes planning and the guaranteed income provided by an annuity can be a valuable option as part of the solution.
This has led to some people taking a two-pronged approach to accessing their pension, purchasing an annuity to cover their core living expenses and leaving the rest in drawdown to cover the more unpredictable costs such as bills or holidays.
Similarly, while the predictability of an annuity might not seem very exciting in the early years of retirement, fast forward a few years and the reliability of income from an annuity could be very welcome.
Drawdown risk
Those using drawdown may love the control they now have over their pension income, but not everyone fully understands the risks associated with drawdown. Just as pound cost averaging helps to boost your pension when you're paying in regularly, pound cost ravaging can help it to disappear much faster when you're making withdrawals on a regular basis.
This isn't so much of an issue if there are other income sources, but can leave the uninitiated facing a much less comfortable lifestyle in retirement. Here, what's particularly concerning is that the FCA report found the percentage of people going into drawdown without taking advice had increased from 5% before freedoms to 30% now.
Annuity makeover
Given what's at stake when individuals make the wrong choices with their pension pots, it's important to note that there are ways to get better value from an annuity.
Shopping around is essential. While most advised customers will do this, the FCA found that just 30% of those without an adviser look beyond what their pension provider offers them.
As well as shopping around it's also important to find out whether health and lifestyle factors could result in a higher level of income. Around 70% of people qualify for enhanced annuities, with everything from alcohol consumption and body mass index to serious conditions such as cardiovascular disease and cancer resulting in a higher income.
As an example, figures from Just issued in February 2017, one of the companies active in the enhanced annuity market, show that a 65 year old with a £100,000 pension fund would get £4,789 a year with a standard annuity. If they smoked 10 cigarettes a day, this would increase to £5,203; while if they had had a stroke it would be £6,163.
Get personal
With so many people able to access a higher income by opting for an enhanced annuity, alerting employees to this option as they approach retirement is essential. Knowing they might receive more from an annuity allows them to make a much more informed decision about their retirement income options.
While the additional freedom and choice around taking an income from a pension is very welcome, it's also essential that the right information is available in the run up to retirement. With this, more people will be able to make the best possible decisions about their futures.
Debbie Falvey is DC proposition leader at Aon Employee Benefits.
This article was supplied by Aon Employee Benefits.
