Monday, 24 March 2014

Are annuities dead?

According to most financial papers, the answer is yes……

This means that companies like Just Retirement and Partnership Assurance are dead because this is the majority of their business.

But perhaps the journalists and markets are overreacting.

More choice

The retirement market needed a radical overhaul.

Within the last twenty years guaranteed pension schemes have declined significantly, with only 13% of final-salary schemes open to new joiners and very few FTSE 100 companies offering schemes to new members.

This means a new generation of savers have to adapt to an uncertain retirement in terms of income also life expectancy.

Mixed in with increased life expectancy, lower gilt yields mean annuities have reduced significantly over the past decade.

Pension drawdown was introduced to provide flexibility in retirement. However, the fear was that individuals would use all the money to “rinse” their fund. Therefore protection was put in place.

In the last five years these factors have come to a head, and until now no government has been bold enough to tackle this head on.

Are annuities dead?

The assumption is that individuals will be happy to take control of the management of their pension fund in retirement. There are a number of elements to this, firstly how much income is needed, how the remaining fund is invested and how long it is expected to last.

When the dust has settled the outcome will be that some individuals will be happy to do this, some will outsource to financial planners and some will opt for annuities.

What we may see are new product ranges but effectively there will be no change other than individuals will have more choice and flexibility.

Is this good news

Yes, individuals have been asking for some time to have more choice in retirement and these changes respond to this.

However, there are some obvious dangers.

  1. If an individual takes the entire pension fund out, then it will be taxed as income. This means a pension fund of £100,000 will actually be worth around £81,000 after tax
  2. Individuals going into retirement homes could find that their pension is assessed as eligible to pay the fees. Where before there was a restriction on the income from the pension, there is now no restriction. This means potentially the pension could reduce a lot quicker leaving nothing for the spouse or dependents
  3.  Security – annuities provide security, assuming life expectancy is twenty plus years then individuals opting for annuities know they will get a guaranteed income until they die. For some this will remain an attractive option. If individuals believe this is wrong then drawdown or taking all their pension fund as cash opens up a greater degree of risk because the responsibility for ensuring the income lasts rests with the individuals
  4. Financial education – there is an assumption that financial education is strong, however a number of reports indicate that this is not the case and that our schools are failing our children. If the financial education is not there then this opens up potential dangers where money is wasted and squandered

Where now

This is great news but needs to be handled carefully. One of the greatest fears about drawdown was that individuals would “rinse” their pension fund and then the state would have to provide for them, protection was put in place to stop that. That protection has now gone but those fears remain.

Individuals reaching retirement now have access to “free” advice and will need to make a choice. Annuities although appearing to offer poor value for money do offer security whereas drawdown requires careful management to ensure the same level of security; ultimately this will depend on the individual.

The markets (and analysts) have priced in armageddon for Just Retirement and Partnership Assurance on the assumption that annuities will never be written again. They could be right but in reality one of greatest fears in retirement is uncertainty and hence the use of cash, will individuals want to give up the security of annuities?      

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