With bond yields at an all-time low, helping a client to decide how they take their income at retire...
With bond yields at an all-time low, helping a client to decide how they take their income at retirement is not an easy process - whether it is through annuities, income or phased drawdown on one of the new products on the market.
Stewart Ritchie, pensions development director at Scottish Equitable takes a look at the options and highlights the issues your clients need to know.
Almost all of the recent publicity about annuities has centred on people wanting to avoid buying them. This is because of their perceived inflexibility and, especially, the loss of capital when an annuitant dies. But it is important to remember the good points about annuities, and why they are right for most people.
In its present form, an annuity is insurance against outliving your assets. As with any form of insurance it operates by averaging out the experience of a large group of people, some of whom will live a long time and some of whom won't.
If you die early after annuity purchase your beneficiaries will get back less, sometimes much less, than the price of the annuity less the annuity instalments while you were living. The risk of poor value on early death can be offset by having a high guarantee period or a high element of spouse's reversionary annuity, but at the cost of a lower starting pension. If the client is in poor health an enhanced annuity rate may be available in recognition of that fact. But most people hope that they will live a long time in retirement, and medical advances might make that a very long time. It would be a shame if you couldn't enjoy those extra years because you had run out of money and had to rely on uncertain, but certainly modest, means-tested State benefits.
Apart from longevity insurance, the major component of annuities is investment. With conventional annuities the life office determines the pension instalments on the day of purchase, based on fixed interest stocks, and you know exactly what you will get for as long as you live. It is possible to have a "with profits" annuity would give some exposure to equities, but with a degree of smoothing, as well as to have directly equity-linked annuities. With both of these annuity types there is the risk that the annuity payments could go down, or will not go up from a low base.
In the last year or two the Inland Revenue has been prepared to negotiate with individual life offices regarding lower longevity insurance and greater investment flexibility. This has led to innovative products being launched successively by Canada Life, Prudential and London & Colonial. There may well be more [innovative products] in the pipeline, however, market observers suspect that not many of these innovative products have yet been sold. If true, there may be several reasons for this. It may be that it takes time for the new ideas to be accepted; perhaps people are put off because the new products are difficult to understand, or perhaps people are holding off because they think even better products are just around the corner.
People who are members of final salary pension schemes don't need to get involved in decision-making on annuities as that is done for them by the scheme trustees. People who are members of occupational money purchase schemes also have trustees to do this for them but should the trustees fail to get the best annuity rate for the member, it is the member who suffers, not the scheme. The trustees of a money purchase occupational scheme may offer income drawdown, but this is rare.
In both cases, it may be possible for the member to take a transfer across to the new personal pension/stakeholder regime, where annuities, phased vesting and income drawdown are all available. Phased vesting enables the pension to be taken in stages, which is particularly useful where the individual is gradually stopping work. This also averages out costs if annuities are purchased when each pension slice is vested.
Income drawdown has become very popular with personal pension clients who have a relaxed risk profile. It enables them to vary income, maintain investment control and if the client dies early the residual capital can be applied for the benefit of the family. If the client survives to age 75, an annuity must then be purchased. In practice, it may be better not to wait until the last minute to make the purchase because then there is no room for manoeuvre if the annuity market and the market value of assets in the pot are depressed.
It is possible that the Prime Minister's wife will gallop to the rescue of reluctant annuitants. Cherie Booth QC is representing Joe Singer, a 75 year old who doesn't want to buy an annuity. The court case is due to be heard before Christmas and most lawyers seem to think that there is little chance of Joe Singer winning, but we shall see.
Perhaps if people did not feel forced to buy an annuity they would pay more attention to the genuine attractions of that route. Even as things stand, it is obviously a complex area crying out for independent financial advice.
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