Written by Nigel Barlow, Head of Retirement Solutions at Just Retirement Ltd
Whether you’re an adviser or provider, the at-retirement market has highly accessible opportunities. The number of people entering retirement each year is growing and with more and more companies chasing their individual pension funds, they are being faced with an increasingly broad range of options. Confusion is rife and the demand for advice from this group is therefore likely to grow substantially.
Once, the only real choice for the vast majority of those with individual benefits was to purchase a conventional annuity with their fund. Over the past decade or so, the landscape has changed and the choice has widened.
It is not uncommon to see comment proclaiming that people or advisers don’t want to buy an annuity and that use is declining. Just Retirement’s research shows that the issue is not a case of not wanting to buy an annuity but rather that the majority don’t actually know what an annuity is. In a sample of over 1,000 people, 28% had not heard of an annuity, 5% were not sure and of those that had, almost half were unable to identify an annuity correctly.
It is, however, a fact that more than 450,000 conventional annuities were sold in the pensions market in 2008, up 5% on the previous year. Sales of enhanced or impaired life annuities rose 31%. It is forecast that annuity sales will reach £20 billion by 2012. So there is clearly considerable interest in selling them.
The level at which an individual would wish to take risks with a pension fund is a function of attitude and circumstance and will depend heavily upon the ability to guarantee a specified minimum level of income regardless of fund performance or external events. The specified minimum income will vary by individual but, at retirement, should be straightforward to estimate in discussion with their adviser. It will be a combination of:-
- State benefits
- Defined benefit pension
- Individual or DC pension
- Income from investment or savings
- Income from earnings
Those with full State pension, including second tier benefit and long accrual under a defined benefit scheme will have a secure base, substantially index-linked and may be capable of taking a high risk with any individual DC benefit regardless of size of the fund. Those without a similar cushion may have to be more careful about size of fund as they must be sure of generating sufficient income without undue risk. Any sudden shock, as in the current market conditions, endangers living standards.
The relative few with larger pension funds may well choose to adopt the Unsecured Pension route and leave funds invested to recover while they draw a reduced income. This, of course, pre-supposes that they can afford to draw a lower income and, even now, the flexibility of USP is being affected by the fact that the gilt yield, upon which the maximum drawdown is based, has fallen to 3.25% and could fall further. An annuity is a guaranteed income for life, not reacting as violently to market instability. Line them up side by side and in order to maintain the same level as an annuity an Unsecured Pension fund needs to grow by 7.5% each year (or 8% for an enhanced life) just to stay on track. Additionally, clients eligible for an enhanced annuity can typically increase their income, above a standard annuity, by up to 33% and up to 60% for more serious cases.
Those facing retirement could well be concerned by the current uncertainty over investments, house prices and annuity rates. Recent bonus announcements on with-profits policies have not been encouraging, especially given the news about terminal bonuses and will leave many scratching their heads over how they will be able to afford to live. Obviously there are also wider considerations here, in particular whether people are saving adequately for retirement and whether or not they are paying sufficient attention to the investment of their money and reviewing their arrangements frequently enough to be prepared for any shocks that may arise.
The data from the ABI suggests that a very large proportion of funds are too small to be proof against short term shocks. Projections indicate this will be the case for a long time to come and so the vast majority will be best served by simply shopping around to secure the best income they can from an annuity. It is likely that there will be an increasing number of larger retirement funds materialising over the next decade or so and the availability of flexible investment options for these will make a big difference, subject to careful planning.
Alongside this, however, there will be an even larger number of smaller funds with people requiring straightforward assistance needed to secure the best guaranteed income for the rest of their life. For the vast majority, an annuity will be the very best way of achieving this.
