|
20/07/2010 | |
|
Written by Mike Morrison, Head of Pensions Development, July 2010 This information is directed at professional financial advisers only. It should not be distributed to, or relied upon, by retail customers. As the focus of retirement planning moves to decumulation the key question is whether to annuitise or not, and if so, when? Until 1995 annuitisation was the only real option of converting an accumulated pension fund into retirement income. The introduction of income drawdown (now referred to as Unsecured Pension) in 1995 drastically changed the landscape. For many people an annuity is the only real option, and annuities do have their attractions as they will pay out as long as the annuitant is alive and they enjoy a cross subsidy with those living longer benefiting from those who die before their assumed life expectancy (mortality cross subsidy or mortality drag). However, annuity rates are linked to interest rates, and falling interest rates have meant falling annuity rates. Annuities are also criticised for the poor death benefits and the feeling of not getting value for money in the event of early death. At the other end of the scale, income drawdown gives no guarantees, better death benefits but introduces investment risk into the equation. In the early days of income drawdown the perceived view was that it was not really suitable for anyone with a fund of less than £250,000 to £300,000 and even then, the assumption was that such people would have other assets and therefore would be able to withstand some volatility in their investments. Over the years income drawdown has often been predicted as being a regulatory problem waiting to happen but so far so good, it is however still an issue that is on the radar of the Regulator. At the end of April 2010 the FSA published its Financial Risk Outlook for 2010*, a detailed look at some of the significant developments in the regulatory environment and which assists the priority setting of the FSA. The following is a quote from that report: “…Some consumers have been affected by a combination of these factors, particularly those close to retirement. As a result, some may face lower retirement incomes than they would have expected a few years ago. Annuity rates have continued to fall due to low nominal interest rates and rising longevity. The average male annuity rate was down by 10.5% in the year to October 2009, whilst female annuity rates were down by 10.9% over the same period. Falling asset prices may have reduced the value of pension pots. Furthermore, those consumers intending to use the equity in their home to help fund retirement, either through mortgage equity withdrawal or downsizing, may find that there is less equity available than they were expecting.” The report continues: “An increasing number of consumers, especially those moving from defined benefit to defined contribution pension schemes, may demand products which allow decumulation of capital. However, this is an area where consumer financial capability is particularly low. For many, an annuity will be the most appropriate option. However, people approaching retirement may be more susceptible to sales of income drawdown because, as discussed earlier, annuity rates are lower and could generate an income below consumers’ expectations. These factors create the conditions for potential mis-selling of products…” The FSA recognises that annuities provide certainty but also understands that the market for “flexibility” is growing. Annuity rates are lower and as people live longer it takes longer for the benefits of mortality cross subsidy to appear (perhaps nearer to 70). In such circumstances it is not surprising that consumers do not want to commit themselves to an annuity too early – but do they understand the risks of not doing so? Even more problematic are those individuals with funds of perhaps between £100,000 and £200,000 who perhaps feel they are able to take the risk of income drawdown at least as a way of deferring annuity purchase for a few years. In reality they may not be able to withstand too much stock market upheaval and be reliant on the income that their pension fund can produce. The FSA continues: “A related risk is that consumers who buy drawdown products do not understand the need for regular review or take the after-sales advice offered to them to help decide when to purchase an annuity. While the market for income drawdown is small, there has been a significant increase in the volume of sales in recent years… Firms providing income drawdown, or advising on it, should bear in mind that this product is unlikely to be appropriate for consumers with pension pots under £100,000” So is it just a case of drawdown versus annuities? I think we need to break down these products into their key characteristics and develop new ideas. As a market we do need to address the pros and cons of annuities and drawdown and recognise that consumers’ needs may not be addressed by one or the other. In this light we have started to develop so called “third way” products or variable annuities with the aim of providing access to investment performance with a downside guarantee. This means that there is a possibility of increasing income (like drawdown) with the ability to limit a fall. So far, these third way products have been criticised as being complex and costly but they are gradually starting to provide an alternative. Future changes to our pension regime, such as changes to the age 75 situation, could be a boost for such products - particularly if they are allowed to continue beyond age 75 in the future. The age of the third way product may not be upon us yet but I am sure that we are on our way to widening client choice. *Financial Risk Outlook is available on the FSA website: http://www.fsa.gov.uk/Pages/Library/corporate/Outlook/fro_2010.shtml |
|
| ‹‹ back | |
